VIEWS: 8 PAGES: 6 POSTED ON: 8/27/2012
Conflicts That Financial Advisors Do Not Want You to Know By AL Hewitt, CFP, EA, ATA, ATP, AAMS, AWMA By taking the time to read this report you will learn how the financial services industry does business ninety-nine percent of the time. You will find that it is in your best interest to become part of the other one percent. The financial services industry is famous for complicating the way you choose a financial advisor, and how they are compensated. With over fifty types of financial certifications, varying compensation models, and multiple regulatory agencies, the industry has created a mass confusion. Here are the two most common business models used by advisors in providing investment advisory and financial planning services: Commissions Commissions on Financial Products: How They Work The advisor is paid by, and works for, someone other than you such as: a credit union, broker dealer, brokerage firm, bank, or an insurance company. Many financial advisors will give away free financial advice and even a “boiler plate” (computerized financial plan); in turn, you may purchase recommended financial or insurance products from the advisor (mutual funds, annuities, insurance, etc). The advisor will receive a commission from the product company. Commission payouts range from 1% to over 10% depending on the type of products purchased. The goal of commission based advisors is to get hundreds if not thousands of customers to buy the product they are selling. The advisor must constantly solicit for new business to earn commissions limiting the advisor’s time to manage your financial plan. Commissions for Products: The Intent The intent of commissions for investment products is you only pay once or not at all if you keep your assets with the same company for a specified period of time. Some products have up front sales charges as high as 8.5% while others have no up front sales charges. ·Reality – Financial service providers may have agreements with certain mutual fund and insurance companies that pay more commissions and give the firm various incentives that you may never know about, these programs have various names that may include: premier sponsor, strategic partners, revenue sharing, marketing support programs, and preferred provider arrangements. Most commission based advisors will use only one fund family, limiting the selection of money managers, making diversification difficult to achieve. Competing product companies also pay the advisor a differing amount, especially for selling annuities and life insurance. If one product pays a commission of 10%, the advisor has no incentive to offer you a product with lower annual fees that only has a commission of 1%. ·Reality –The products you will be sold, have higher annual fees than many other types of products currently available in the marketplace. These fees and charges could range from 2% to 5% every year and will erode your portfolio, these include: 12b-1 fees, account fees, management fees, tax charges, turnover costs, mortality and expense charges, living benefit expenses, enhanced death benefits, sub-manager fees, and SAI charges (Statement of Additional Information) these fees are for trading expenses, custodial expenses, legal and accounting expenses, transfer agent, and other administrative expenses. These fees and expenses will have a significant impact on your long-term wealth. For example, if you have a $250,000 investment and receive an average annual rate of return (after expenses) of 8% for 20 years, an additional 2% of annual expense charges will cost you $319,406 over that time. Other fees and charges you could incur may be sales loads, contingent deferred sales charges, surrender charges, exchange fees, redemption fees, dealer spreads, and purchase fees. ·Conflict – Many advisors and their employers receive multiple incentives which can be monetary or non-monetary for using certain investment and insurance companies. Some of the incentives are: payments for advertising, gifts, bonuses, soft money incentives, paid trips, vacations, seminars, food, etc. Commission based advisors are not required to disclose all conflicts of interest, and they do not want you to know they exist. These multiple conflicts make it difficult to determine if you are choosing an advisor that will be working for you or one that will be working for the interests of their employer and the various product companies that pay the advisor’s commissions. 2 ·Conflict – Brokerage firms and broker dealers have many business practices that have built in conflicts of interest which may include: pay-to-play, directed trades, revenue sharing, in-house products, make-a-market in securities, and underwriting new securities. These built in conflicts may limit the selection of investments available and your advisor’s ability to provide the most cost effective solution for you and your family. ·Conflict – Commission and fee-based advisors are not held to a fiduciary standard. Fiduciary standards are only required for Registered Investment Advisors (RIA’s) and Investment Advisor Representatives (IAR’s), commission and fee-based advisors are held only to a suitability standard. Advisors that are held to the fiduciary standard must comply with the following: sign a Fiduciary Oath, display loyalty to you, not be compensated by any one other than you, not be affiliated with any competing interests, fully disclose all conflicts of interest, do not receive referral fees from other service providers, and do not receive financial incentives for recommending specific financial or insurance products. It is estimated that over ninety-five percent of financial advisors are not held to the fiduciary standard. ·Conflict – By using commission and fee-based advisors, you may be supporting other organizations and companies you do not even know about, such as: credit union organizations, banks, brokerage firms, insurance companies, and various multi-level sales groups. Ask questions and perform proper due diligence on others who benefit by you doing business with the advisor and their employer. You may find that you will be supporting organizations and companies that are not part of your core values. Asset Management Fees It is estimated that over ninety percent of all fee-only financial advisors and most fee-based advisors charge a percentage of assets under management as their compensation model and here is why: Asset Management Fees: How They Work Typically, your financial advisor will manage your investment assets (i.e., Individual Retirement Accounts (IRAs), brokerage accounts, trust accounts, money market funds, etc.,) through a single custodian firm (i.e., Fidelity, Ameritrade, Charles Schwab, etc.,) that the advisor uses to hold your assets. Your financial advisor may have discretionary authority to invest assets on your behalf or non-discretionary authority, in which case only you have access to your funds. In either case, the custodian firm pays your financial advisor the contractually agreed asset management fee on a quarterly basis directly debited from your account. The withdrawal of these fees from your account is shown on your account statement sent by the custodian. Asset Management Fees: The Intent Asset management fees sound wonderful in principle. Your financial advisor is paid according to the dollar value of your assets under his or her management. The theory is that the more money you have, the more complicated your finances must be, and therefore the more money it costs to “manage” those assets. Your advisor has an incentive to grow your assets which in turn, makes you wealthier. Of course, the more assets under management, the more money your advisor makes. It is a win-win arrangement. Or is it? Asset Management Fees: The Reality The reality of asset management fees is not nearly as clear as the theory. Multiple conflicts of interest exist if the advisor’s compensation is tied to a percentage of assets under management fee structure. Advisors who use this fee model may not clearly explain all of the conflicts that are present during your relationship. ·Conflict – The investments that may be utilized for your account typically have higher expense ratios and higher SAI charges than other investments available in the marketplace. Having these types of products may cost you an additional 1% to 3% per year in expenses. For example, if you have a $250,000 investment and receive an average annual rate of return (after expenses) of 8% for 20 years, an additional 1% of expense charges will cost you $175,134 over that time. Always ask the advisor what are the total expenses that you will be incurring which includes the advisors fees and all of the expenses for the products to be used. Many advisors do not know the total expenses for the products they offer. ·Conflict – Deferred compensation plans, 401(K) plans, 403(B) plans, and pension plans, are not favored by advisors because they normally cannot collect asset management fees or commissions for such accounts. Instead, advisors will aggressively push for rollovers of these plans to IRAs so they can collect their fees and commissions. Many advisors are not familiar with the tax and financial benefits of these plans and do not manage them. There are many good reasons to leave your employer sponsored plans in place, but most advisors have no incentive to tell you that and are not allowed to actively manage these types of plans. 3 ·Conflict – Financial advisors who charge a percentage of assets under management have an incentive to keep and acquire as much of your assets under their management as possible. Priorities, such as: paying down debt, making a large purchase, real estate acquisitions, vacationing, college funding, and gifting to charities or children, may not be taken into consideration. Such decisions are rarely straight by the numbers and it is easy to argue them either way. You may receive biased recommendations when addressing these issues. ·Conflict – You are not an attractive client if you have not already accumulated sizable assets. Many financial advisors require minimum asset levels, typically $1,000,000 or more. The smaller the account size, the less attention you may receive. How Can You Avoid All of These Conflicts? How your financial planner is compensated determines what advice and services you will receive. It is the key difference between an advisor and a salesperson. Do not use or continue to use any financial advisor with these conflicts of interest or who is not held to the fiduciary standard. The financial services industry has poorly educated the public about the conflicts that pervade the marketplace. Having an advisor with any conflicts of interest or who is not held to the fiduciary standard may be detrimental to your family’s financial welfare. At AL Hewitt, Inc., we believe there should be no conflicts, the advisor must abide by the fiduciary standard at all times and that compensation for financial planning and investment management should be based on a fee- only business model utilizing, a flat annual retainer fee. We are paid for our time and expertise, and it eliminates conflicts of interest. We work for you, not for any financial services organization. We offer unbiased advice that is best for you and your family. Our firm offers full comprehensive Financial Life Planning we are proud to offer flat retainer fees for our programs. Give us a call today for a free initial consultation by telephone or in person to see how we can help you and your family. Useful Websites: www.napfa.org www.focusonfiduciary.com www.cfp.net 1120 West Avenue M-4 Palmdale, California 93551 400 Camarillo Ranch Road Camarillo, California 93012 (877) 254-3948 Visit our website at: WWW.ALHEWITT.COM This brochure is based on the beliefs of the author’s view of the financial services industry today. This brochure is for educational purposes only and is not for the purpose of offering tax, financial advice, or an investment approach. The information found in this brochure is recognized as dependable, but is not guaranteed. No portion of this brochure may be reproduced in any form without written permission. AH0006 CONFLICTS OF INTEREST Listed below are potential conflicts of interest that can occur when dealing with certain types of financial organizations. These may cause advice from those organizations to be biased due to payments they receive and the types of products and services they offer. Products and services that you implement through advisors who accept commissions of any type have multiple conflicts of interests. You may incur higher annual fees and expenses for these products and services than you would incur for services offered by Fee-Only financial advisors. FIRMS AND AL HEWITT, INC. ADVISORS THAT A REGISTERED BROKERAGE USE CONFLICTS INVESTMENT FIRMS INDEPENDENT ADVISOR BROKER- DEALERS Fees and/or commissions Fees and/or commissions including front-end including front-end loads, surrender charges, loads, surrender fees, deferred loads and 12(b) deferred loads and 12(b) FEE-ONLY 1 commissions plus 1 commissions plus Compensation other compensation other compensation No Commissions of payments – see below. payments – see below. any type May also charge asset May also charge asset management fees in management fees in addition to commissions addition to commissions known as FEE-BASED. known as FEE-BASED. AUM Method advisor charges a percentage of assets under management on assets advisor manages. Multiple conflicts arise using No Almost Always Almost Always this method due to increase and decrease of account balances and if any withdrawals and or deposits are necessary. Pay-to-Play (shelf space arrangements for mutual funds – will not allow our No Almost always Usually representatives to sell these products unless you pay). Directed Trades (broker dealers charge more for security trades for mutual funds than institutional rates No Almost always Frequently based upon how much of a mutual fund is sold that by broker dealer). CONFLICTS OF INTEREST (Continued) FIRMS AND AL HEWITT, INC. ADVISORS THAT A REGISTERED BROKERAGE USE CONFLICTS INVESTMENT FIRMS INDEPENDENT ADVISOR BROKER- DEALERS Revenue Sharing (direct payments to broker-dealers based upon how many dollars have been directed No Almost always Almost always toward a mutual fund and/or based upon assets currently invested). Bonus Commissions (additional compensation paid based upon sales No Always Always incentives for a particular period of time). Payments to Sponsor Conferences and/or No Always Always Meetings In-House Products No Always Almost Always Securities in Inventory No Always Often (usually bonds). Makes a Market in Securities (a form of Investment Banking - usually No Always Sometimes over-the-counter stocks and bonds). Underwrites New Securities and Provides Support (called Investment Banking) No Always Frequently – pushes products to their clients. CONFLICTS OF INTEREST (Continued) AL HEWITT, FIRMS AND INC. ADVISORS THAT BROKERAGE CONFLICTS A REGISTERED USE INDEPENDENT FIRMS INVESTMENT BROKER- ADVISOR DEALERS Must Disclose in Writing all Conflicts of Interest, both Active and Potential that Yes No No may/might exist in your Relationship. Financial Advisors/ Planners are held to a Fiduciary Standard in ALL dealings with you and your family Yes No No concerning all financial affairs, and have signed the NAPFA Fiduciary Oath. Advisor accepts soft money incentives such as paid education, paid conferences, paid trips, paid travel, paid No Almost Always Almost Always advertising, major gifts, complimentary meals, free vacations and cruises. Advisor accepts promotions such as referral fees or incentives, kickbacks, dealer No Almost Always Almost Always incentives, or insurance company bonuses.
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