Brokers Are Salespeople, Not Financial Advisers
Stockbrokers facing the general investing public, working for JP Morgan Chase, might have business cards with a title of “financial adviser,” but just like the people you meet when you walk into a car dealership, they are salespeople. They are rewarded when they meet their sales targets. Their bonuses are based on the clients they sign. And they put their own monetary goals, like earning those bonuses, before the needs of their customers.
Some financial planners are considered fiduciaries. They are bound by their ethics to consider a client’s needs and recommend the best investment products for each situation. The practice isn’t perfect even among fiduciaries, but with stockbrokers disguised as financial advisers, investors are bound to run into a variety of conflicts of interest. One of those conflicts arises when a financial institution selling investments also has their own products to sell, and the company’s own products are more profitable.
Walk into any supermarket, and the shelves include at least two brands for each product. Shoppers have a choice between store brands and name brands. Thankfully, I can shop for groceries without hearing pitches from salespeople for each product I put in my cart. If I had to go through a grocery broker from the store for each product, and if the store brand items were more profitable for the company than name brand items, I would expect to be pitched the store brand items, even if they were not nearly as good as the alternatives.
In the grocery store, sometimes the store brand version of an item is nearly identical to the more widespread brand. But that’s not the case when you evaluate mutual funds. The in-house funds and investment products salespeople at JP Morgan Chase were encouraged to sell were inferior to other products they offered, presenting lower performance and much higher fees. There’s no surprise, there. Many other large investment banks, however, like Morgan Stanley and Citigroup, no longer offer in-house funds and investment products to their advisory clients.
Just the fact that a broker doesn’t offer her or her own company’s investment products doesn’t mean they’re fully objective in their sales recommendations, however. Brokerages often receive kickbacks for recommending an external company’s investment products to its clients.
The only real solution is for individual investors, hoping to build wealth over the long term, to do their own research. Meeting with a Certified Financial Planner for some guidance can be a move in a positive direction, but each investor should take control of his or her own investments. From there, it’s simple. Fees are negatively correlated to investment returns compared to their benchmarks; if you want the best performance, choose index mutual funds with the lowest fees.
I knew that I wanted to invest in Vanguard’s low-cost index funds before I met with a financial planner. For its investors, Vanguard offers free meetings with a Certified Financial Planner who does not act as a salesperson. The CFP helped me formulate an investing strategy based on my assets today and in the future, and on my goals and concerns. We talked about stock funds, bond funds, and concerns about tax, and formulated a strategy that keeps my tax exposure low. When the plan was complete, I took the information and applied it to Vanguard’s own funds.
I could have used the plan with any company’s funds, even expensive, actively managed mutual funds, if I wanted. I did not just hand over money to this adviser and ask him to manage it for me, a sure way to spend more money than necessary and welcome the possibility of not even meeting benchmark returns.
There’s a possibility that I made mistakes. It’s impossible to say what the best decision is until years have passed and you have the benefit of looking back on the investments’ actual performance over time. Sticking with low-cost index mutual funds is very likely a better idea than trusting a salesperson with the task of looking out for you.
New York Times Dealbook
Not everyone has the time or inclination to manage their stocks or mutual funds closely. For those people, index funds are the best way to go. That’s what Warren Buffett says. While it’s true that an index fund won’t beat the market, neither will it lag the market.
And (again according to Mr Buffett’s word) more than 75% of the managed mutual funds out there underperform the market. That being the case, if you stay level with the market, you’re doing better than 75% of the mutual funds out there.
One final note: there will be another recession in our future. There always is. They come at 7-10 year intervals (you can look it up). Nothing gloomy or doomsday about it. And it will pay you to stay abreast of the economy and move your investment into a money market at some point. Yes, I know about “don’t time the market” but at the same time there are some basic indicators to tell you when we’re coming close to the cliff…
Indexing can be an active strategy if done in the context of an asset allocation plan with reviews and rebalancing at regular intervals. Studies show that the overwhelming majority of an investor’s returns are due to asset allocation and not the selection of individual investment vehicles.
I personally recommend to every investor to have his own research on the market where he is going to invest because sometime financial adviser not have the actual idea that how much you can invest. In other cases, you should hire financial adviser from the successful business firm so that he could tell the ups and downs of the business and how to make it stable.
I’m not a fan of using a stockbroker to manage my investments. I prefer to make my own decisions when it comes to making investment decisions.
Our first financial advisor was clearly a sales man, trying to get me to convert my entire 401k into an annuity. We chose another financial advisor who clearly had our interests in mind. The difference in advice between the two advisors was stark.
Nice article and a great job of clarifying some of the differences among different varieties of financial advisors. As a fee-only advisor I’m biased, but from where I sit I can’t imagine any good reason for an investor to go with a commissioned financial sales person. One area of confusion for many folks is distinguishing between the terms “fee-only” and “fee-based.” The former is what is sounds like, fee-only advisors receive their compensation only from the fees charged to their clients for their professional services. There are no sales commissions, the advisor has no financial incentive to suggest one financial product vs. another. Fee-based is just another version of the commission model. Typically here the client may pay a fee for the financial plan, but if they choose to work with the advisor to implement his or her recommendations this would involve the sale of financial products for which the advisor is compensated.
I am sorry to say this, but I really don’t trust sales people much. I believe they are only after your money, making a sale, and reaching their sales target. Even when I am doing my grocery and a sales person approaches me to buy their product, I simply ignore them as I am not comfortable being followed around, only to realize that they really do not know the product they are selling after asking them several questions.
The best sales people will actually look out for their clients. Having worked sales (never on commission) i would always try to do this. The only down side is these sales people don’t often last very long and you have to find new ones to work with. Managers just don’t seem to like you telling someone the house brand is crap or making recommendations that don’t help their bonus.
You definitely need to be careful whenever getting information from a financial adviser. Make sure you know how they are compensated! That will often tell you if they’re taking you to the cleaners or not.
Thanks for the clarification. Good to get the reminder that ultimately it’s your money and you need to research what is best to do with it for you.
Flexo – an index fund tracks a given index & charges you a management fee (albeit a low one). Thus, you will NEVER beat your index. Just saying it’s hard for an actively-managed fund to beat it’s index (or benchmark), but an index fund will never beat it.
Surprisingly, this isn’t quite true.
Some of Vanguard’s index funds have a tendency to perform closely enough to their indexes that they actually do outperform them (very, very slightly) in some years. For instance, Vanguard 500, Vanguard Total Stock Market, and Vanguard Value have each beaten their indexes over the last 5 years.
You’re not going to get big outperformance with an index fund. But with a very good one, you’re not going to trail the index by much either.
Of course, none of that’s really very important from the perspective of an individual investor. What really matters is simply: What mutual funds are likely to earn the highest returns? (And from what I’ve seen, the studies seem to consistently answer, “those with the lowest costs.”)
Thanks for opening my eyes, Flexo. I guess I wanted to think that brokers were client focused but now I see that that isn’t so. Now I’m glad I do my own investing, sort of. My returns of late aren’t stellar, but at least I’m not giving up extra money in fees.