Published On:Monday, January 20, 2014
Posted by devil
The Secret Wall St. Doesn't Want You to Know By Keith Hawk
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I pride myself in being an honest person and doing the right thing no matter what the situation is. I will always be this way due to how I was raised and taught by my mom and dad; the values ingrained in me: always strive to do the right thing, and when you can, help others. Unfortunately, not everyone shares this same viewpoint, especially in the industry I have chosen as a profession, the financial industry. I felt like shedding some light on a taboo subject that isn't too widely known: how do Wall St. and the big brokerage houses actually work, along with how everyone in the financial industry gets paid and why.
In the financial industry, not all "financial advisors" are created equal. Everyone calls themselves a "financial advisor", "wealth manager", or "financial consultant". Even a CFP® (Certified Financial Planner®) has bias and conflict of interest depending on who he works for. Don't be fooled by titles because titles can be deceiving. The reality is that there is bias and conflict of interest due to how someone is licensed in the financial industry. I can't stress this enough.
There are typically four relationships you can have in the financial industry: a relationship with a banker, an insurance agent, a commissioned broker, and a fee-only investment adviser. The banker and insurance agent handle safe money... money "out" of the market, whereas the commissioned broker and fee-only adviser handle risk money... money "in" the market.
Let's start with the "safe" money relationships. Your banker sells CDs, money markets, checking accounts, etc. The insurance agent sells you fixed annuities, life insurance, and long-term care. You can only sell safe money products when you only have an insurance license so there is a natural bias and conflict of interest to only sell you those products.
*Note that since the banks have been deregulated, there are commissioned brokers and insurance agents inside the banks calling themselves "financial advisors". Even CPAs can call themselves "financial advisors".
The next two relationships you can have are with a commissioned broker and a fee-only adviser. They handle "risk" money, money "in" the market. A commissioned broker is tied to a brokerage house. A commissioned broker gets paid by receiving commissions for the sale of class A, B, and C mutual funds, variable annuities, stocks, bonds, and non-publicly traded REITs. Since a commissioned broker is licensed to sell only these products, there is a natural bias and conflict of interest that occurs. You can always tell if you are dealing with a commissioned broker because they have to disclose on their business card or marketing material that they are a "Registered Representative of XYZ company" and "Securities offered through XYZ company" and also "Member of SIPC and Member of FINRA". The conflict of interest is that commissioned brokers typically recommend products to clients that pay them fees generically called a "trailer fee". The conflict of interest is that they want to build up their assets under management or AUM, but what they are recommending to you might not be best for you. The broker may also be tied to a particular fund family and only recommend those funds to you.
A commissioned broker will recommend products that only have to be "suitable" for you. Recommending a suitable investment or product doesn't require brokers to find the best products, only ones that are ostensibly suitable for you. So for instance, if an underwhelming "house brand" security lines up with the vague outlines of what is considered suitable they can still push it, even if it costs more to own, or under-performs peer securities.
They do not have to act in your best interest, and scarier yet they do not have to disclose that the fund they are recommending has high expense ratios (fees) sometimes ten times higher than a similar no load fund.
Acting in the best interest of the client is called fiduciary responsibility. This is what differentiates a fee-only investment adviser from a commissioned broker. Brokers are not known to have fiduciary responsibility. Brokers typically put you in class C mutual funds of the same fund family and do a 60/40 split of stock funds and bond funds. They will use funds from the same fund family anywhere from 9 to 10 funds, sometimes as high as 20 to 30 funds of the same fund family. Ask yourself this, "Does that fund family have a monopoly on the best funds year in and year out? Makes you think doesn't it. On top of that, the internal expense ratios of the funds they put you in are two or three times higher than a no load fund, and the trailer fee also quadruples to 1%.
Here is something interesting, case in point; American Funds are sold by commissioned brokers and they are the 2nd largest fund company. The largest fund company is Vanguard, a no load fund company. Commissioned brokers will not tell you about Vanguard having no commissions and low expense ratios because they cannot receive commissions for the sale of those funds.
A commissioned broker will also sell you variable annuities usually loaded with high fees. The high fees come from the mortality and expenses, the investment fund fees, and the riders (add-ons to enhance the variable annuity to make it seem more attractive). I've seen fees on variable annuities as high as 4 or 5%! The add-ons, or as we in the industry call them bells and whistles, in variable annuities are only beneficial to you if you die, or the market goes down and your account loses money. They also try to sell you the variable annuity due to the income riders. The funny part is that indexed annuities sold by licensed insurance agents have better income riders because they do not have to take on more risk.
Commission brokers want to put all your money "in" the market because of their bias and conflict. You do not want to take an income from money that is "in" the market. Let's say that you are taking 5% per year from money "in" the market and you have $500,000. So your annual income is $25,000 from that money. Well guess what, the market took a turn for the worse and now your account is $250,000 but you still need your $25,000 per year. Well you are not pulling out 5% anymore, it's now 10%. The market drops for another year and your account is down to $125,000 but you still need your $25,000 so now you have to pull out 20%. Now your account has no chance of recouping any losses because you're now in distribution mode and not accumulation mode. When you were working you were systematically investing in your retirement account no matter if the market was up or down. That is called dollar cost averaging. During retirement you are no longer contributing, you're withdrawing. Taking money as income from the market is what I call wealth destruction. As a matter of fact if we were playing a retirement video game it would say: Game Over!
Again don't be fooled by someone's title or even the CFP® designation. It doesn't make that financial person non-biased. It's only a designation. It doesn't tell you if that financial person acts in the best interest of his clients, which again is called fiduciary responsibility. A CFP could just be a commissioned broker in disguise or an insurance agent.
All too many times I have seen statements of clients when they first had a meeting with me, and those statements had 10 to 15 class C mutual funds of the same "house brand" fund family, and/or variable annuities with high fees, and/or non-publicly traded REITs (real estate investment trust) that just sit on their statement because they can't cash the REIT in. They even went as far as putting the clients' IRA into the variable annuity. That is a legitimate tax no-no because IRA's are already tax deferred but depending on your age, your RMD (required minimum distribution) may be drastically affected. Further investigation showed that some of these advisors were CFPs®, but the reality is that they are nothing more than commissioned brokers. Remember that anyone can be a "financial advisor". Most financial advisors are commissioned brokers in disguise. Why is it like this? It's very simple. The brokerage industry is set up to sell you class A, B, and C mutual funds with high expense ratios, bonds or bond funds, variable annuities with high fees, and non-publicly traded REITs. All of these products are fee generating products for commissioned brokers.
The last relationship, a fee-only investment adviser, receives no commissions from a brokerage firm, or a mutual fund company. They are hired to find the best performing mutual funds for you regardless of fund family name. This means they represent you and your interests when giving you advice. There is no bias or conflict of interest when you have a fee-only relationship. Investment advisers are held to a higher standard of care and do not receive commissions. That is called fiduciary responsibility. So if there are 10,000 mutual funds available, which funds will an investment adviser with fiduciary responsibility find for you? That's right, the best ones; the best funds regardless of fund family name.
Investment advisers are paid via a fee. The fee is usually charged as a percentage of the assets they manage for you, and thus debited out of your account each quarter. So for instance, if you hire a fee-only investment adviser and they charge 1.25%, and you let them manage $100,000 of your assets, your fee is $1,250. More importantly, if they want to make $2,500 in fees from you they need to grow your account to $200,000. This puts a fee-only investment adviser on the same side as the table as their clients. They work for you and not Wall St.
Again, fee-only investment advisers have fiduciary responsibility to find investments that are in your best interest. They typically use investments that have low internal expenses such as no load mutual funds, stocks and bonds; investments that have no 12b-1 fees (trailer fees). I can't stress this enough, the investment advisers' objective is to grow your account and find the best performing mutual funds for you regardless of the fund family name. Again, that's fiduciary responsibility or fiduciary standard of care.
It's important to point out that this article is not meant to disparage any particular commissioned broker or insurance agent. There are lots of good brokers and insurance agents out there that do what is in the best interest of their clients. This article is solely meant to educate the public on the war in the financial industry for your money. The commissioned broker will not tell you about products a life insurance agent sells, and an insurance agent will not tell you about products the commissioned broker sells. That's the ongoing war in the financial industry... the risk money people at war with the safe money people. Once you understand this war, it will help you to make better financial decisions.
So the next time you are offered a variable annuity or mutual fund you can ask yourself "is this in my best interest, or is it being offered only because of how that financial person is licensed." The same holds true when someone offers you a fixed or an indexed annuity. You can ask yourself "is this being offered because it is right for me, or is it because that is what the financial person is licensed to sell."
Look at it this way. If you were shopping for a new car, let's say you had it narrowed down to a Toyota and a Ford. You go to the Ford dealership and tell the salesperson you want the Ford, but the Ford person tells you he thinks you should go with the Toyota! When has that ever happened? Never! The Ford dealership is the commissioned brokers, and the Toyota dealership is the insurance agent. The commissioned broker (Ford person) will never tell you to go with the insurance agent (Toyota person), and vice versa. A person who holds an insurance license (Toyota dealership) will never recommend that you should do business with someone in the brokerage industry (Ford dealership). Remember, it's the war for your money! A person who holds an insurance license has a natural bias to want to put all your money in insurance products. A person who holds a securities license will naturally have a bias to put all of your money into risky market products. These two industries are at war for your money.
Hopefully this article has educated you on the differences of the financial industry, and the bias and conflict of interest due to how someone is licensed. Remember not all financial persons are the same. Everyone calls themselves a "financial advisor", make sure to dig deeper to find out what they really are and how they are licensed. Try finding someone you feel comfortable working with, you can trust, most importantly adds value, and can do "safe" money products as well as "risk" money products to put a good balanced plan together for you. It is very rare to find someone that can bring these two competing industries together for you with no bias or conflict of interest. But the good news is that they are out there.
Keith Hawk, AAMS®Investment Adviser RepresentativeHawk Financial Group3322 US Highway 22 West, Suite 425Phone: 908-722-4008Email: keithhawkfinancial@gmail.com
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