Those who seek to safeguard their financial future face many challenges. The difficulties of economics, taxation, complicated mathematics and planning for the future all come together in a convoluted bundle. Each piece can be a challenge and each is significant. An even greater problem looms above all of these, however, and its answer lies at the root of protecting a family’s financial well being. Who can we trust to give us the best possible advice?
The challenge of finding trustworthy guidance is present in every corner of our lives. It is especially difficult, though, in dealing with our money. The world of finance is complicated and intimidating. Furthermore, these decisions involve very high stakes: happiness, comfort, success, health and retirement all hang in the balance. A big error can have grave consequences for the rest of our lives and those of our children. In light of how much is at risk, we want those who guide us in our financial lives to be people who are highly knowledgeable, honest and trustworthy.
The need for expert assistance that combines substantive knowledge and trustworthy care is not new. One of the traditional answers to this problem is to seek out a professional. When our health or our rights are in jeopardy, we turn to a doctor or a lawyer. In the same way, we might naturally look for professional help in safeguarding our financial well-being. The difficulty in finding such help, however, lies at the heart of one of our biggest societal problems. We need something beyond mere technical capability. The word “professional” must not refer just to skill or subject matter expertise. The duties of what I call “true professionals” include not only using technical proficiency in the service of clients but, also, honoring the complex trusts placed in them by those they serve. Using the traditional professions as a model, but expanding the notion to all who would seek to be viewed as professionals, I have long advocated that
“A true professional uses his or her ability and power solely to advance the best and truest interests of the client. When the professional’s interests diverge from those of the client, the professional always follows only the client’s interests.”
Such a “true professional” brings skill, knowledge, training, and experience to bear on the client’s problems. To these are added the notion that service, care and safeguarding are an intrinsic part of professional work.
Most of us know, however, that it is extremely difficult to find such a true professional to guide us in our financial lives. It is true that there are “financial advisors” (bearing a hundred different titles) on almost every street corner. They are anxious to do business with us (sometimes even aggressive), simple to locate, and eager to please. Unfortunately, the typical “financial advisor” does not come close to meeting the standards of a true professional.
Much of the difficulty can be traced to the history and practices of the “financial services industry.” Those businesses, along with the people who were trained and work in them, have long operated in what can be called a “sales based culture.” Not only do they fall short of professionalism but, sadly, they have failed to strive for the higher ideals set out by the traditional professions. The industry has consistently put profits above stewardship, products before advice, and sales ahead of transparency. In short, the financial services industry turns out workers who are far more like salesmen than true professionals. As most consumers know, it is unwise to place much trust in anyone from a sales culture for, to quote a common expression, “they are surely trying to sell you something…”
There is nothing inherently wrong with a sales culture. Most of us have plenty of experience bargaining with salesmen about the price of a car or length of a warranty. These relationships are known in the law as “arms length” and it is understood that each party is looking out for their own interests. Everyone involved knows the Latin phrase caveat emptor -“let the buyer beware”- and the salesman’s motivations are clear. Arms length transactions are considered fair when the parties are pretty much equal in bargaining power and neither party has a distinct advantage over the other.
Significant problems arise, though, when one party to the transaction knows a great deal more about the subject area than the other. Most financial advisors have command of a great many industry practices and norms that are far beyond the knowledge of even very smart “regular people.” They also have experience and training in various routines, techniques and tricks-of-the-trade that give them an enormous advantage over their clients. An economist would describe this as an asymmetry of information between the advisor and the client.
The trouble increases if the client believes that the financial advisor is somehow “looking out for” or has a special duty to the client. Instead of keeping the advisor at “arms length” and being cautious about the information asymmetry, the client may place great trust in the advisor and assume that all industry knowledge will be used solely in the client’s behalf. Few among us would mistakenly believe that the car salesman was watching out for our interests above his own – we know better than that. The financial services industry, however, has failed to confront these problems and has contributed to a lack of clarity concerning the role and duties of its sales force. As a result, the person receiving the advice is badly disadvantaged and very vulnerable to being manipulated.
To make matters worse, there is a natural conflict of interest between a “financial advisor” and client. The financial services industry was built on a system of paying commissions and that is still the primary way most advisors make their money. The result is a terrible conflict between the “financial advisor” and the client: the former wants to make as much money as possible while the latter desires to get the wisest solution. A number of troubling consequences flow from this. Some advisors urge clients to buy those products which offer the highest commissions. Advisors may recommend buying a product when none is needed at all, or buying more than is needed. Thus, for example, a stock broker may suggest a mutual fund with a high sales charge despite research that proves funds with high charges under-perform lower cost funds. An insurance salesman may steer a client toward a two million dollar “whole life” policy when a million dollars of term insurance would cover the need. And, of course, the very word “product” points to another part of the problem: clients aren’t looking for a product at all. Rather, they seek real guidance on how best to meet their underlying interests. Someone selling some commoditized or one-size-fits-all answer is very unlikely to give clients what they really need.
While the financial services industry has a long history of commission based sales, some “financial advisors” do not currently work that way. So called “fee only advisors” are compensated based on some agreed upon rate and, thus, may avoid some of the conflict problems that commissions generate. This is a great step in the right direction, but it by no means eliminates the problems of conflict-of-interest. Indeed, such conflicts seem to show up in every corner of the practice of working with other people’s money. Consider, for example, what happens when the client asks the “fee only advisor” about the wisdom of paying off a mortgage early using funds that would otherwise remain in the investment account.
Many people believe there are laws and regulations in place to deal with the problems of conflicts of interest and asymmetric information between “financial advisors” and their clients. This belief, unfortunately, is for the most part mistaken. Those who hold themselves out as “financial advisors” all have some legal duties to their clients. It is surprising to many, though, just how low the level of those duties can be. People often assume that all “financial advisors” have a fiduciary duty to their clients. Under present law, however, most of them are governed only by a “suitability standard” – a surprisingly low level of responsibility to clients.
The differences between “fiduciary duty” and the “suitability standard” can quickly devolve into a bunch of lawyer-speak but here is the essence. Fiduciaries have a very high level of duty. They owe a duty of care and a duty of loyalty and must not put their personal interests before this duty. All of the fiduciary’s actions are performed for the advantage of the client. Such a duty gives rise to a relationship of trust and confidence. Many people understand this as the level of care and responsibility they expect from their doctor and their lawyer.
The “suitability standard,” on the other hand, requires only that investments or products sold are “suitable” for the client. It does not require, however, any effort to give guidance as to which products are better, more efficient, riskier or wiser. Such a standard, which governs stockbrokers and “broker dealer representatives” under current law, might be understood as similar to what we could expect from a used car salesman.
The financial services industry has lobbied long and hard to resist the introduction of a fiduciary duty to its broker dealer representatives. In a time of growing public pressure for greater financial regulation of all types, it is mounting a campaign in Washington to resist any attempt to extend fiduciary duty to those who sell its many complex and confusing financial products. Even though most fair minded individuals would expect fiduciary duty to be the standard for those who work with people and their investments, the industry resists extension of that level of duty to all those who sell its products. In doing so, it puts another nail in the coffin of any plausible argument that those financial advisors working under the “suitability standard” can reasonably be called professionals.
The combination of conflicting interests, asymmetric information, and modest legal duties to clients creates a situation in which it is unwise to trust most “financial advisors.” They may be decent people with good intentions and a warm heart but, in reality, they are not likely to put their client’s interests ahead of their own. A prudent client would not even expect such unselfishness – and experience shows us that extreme caution is called for in light of typical practices. The incentives are stacked against a “financial advisor” being highly trustworthy and, since they are human, most of them act on their own interests. To make matters worse, there is so much money at stake, and in such a complicated set of arrangements, that the corrosive affects of greed are ever present. Caveat emptor.
In light of this challenging situation, who can we trust to guide us through our financial life? The key to the answer lies in the concept of a “true professional.” Wisdom calls for seeking out someone with technical expertise and extraordinary training but, also, with a strong sense of client care and safeguarding. Search for an experienced practitioner who acknowledges the problems explained here and has taken concrete actions to address them. In particular, find someone whose practice is completely transparent and who struggles to eliminate conflicts of interest. It would not hurt to find a practitioner who has been trained and socialized in one of the “traditional professions” as to the primacy of client interests. Identify somebody who has a fiduciary duty at law, and understands it fully, but recognizes that alone is not enough. The “financial advisor” worthy of full trust will be one who in all ways has sought to act as a “true professional” over a significant period of time.