Fact: The brokerage model is broken and riddled with conflicts. When the Glass Steagall Act expired 15 years ago, transparency took a flying leap off the tallest bridge. And if you're waiting on Dodd-Frank to make amends, don't hold your breath; there's always a way to get around a regulation -- not that many rules have constrained what commission-based investment advisors charge.
I spent 25 years as an investment advisor for some of the world's largest investment banks. I learned all the tricks, the sleights of hand, the rehearsed speeches that plug the latest and greatest investment.
Now, I run a company that's a broker watchdog. I investigate the investment advisors and companies to whom people entrust their money -- and, as with stocks, there are winners and losers. I'll tell you what most financial advisors won't -- the essential truths about how Wall Street operates. You? You're a supporter of some investment advisor's way of life and a brokerage firm's bottom line.
How do you make sure your relationship with an investment advisor isn't completely one-sided? These four truths can help keep you on the right track.
1. What you see isn't always what you get
Want to make sure your investment advisor is on the up and up? Check him out through the Financial Industry Regulatory Authority's BrokerCheck or the SEC's Investment Adviser Public Disclosure website, and you'll learn everything you need to know, right? Not necessarily.
Complaints against FINRA member firms and advisors are sometimes expunged as a condition of settlement with the customer. FINRA says it expunges less than 5% of complaints from brokers' records. However, I for one would like to know if my broker had legitimate complaints against him that magically disappeared from his record.
FINRA may soon consider a rule to prohibit such record erasures, but even if a rule is eventually implemented, you still have to do your due diligence. Many investors don't learn about advisor misdeeds until they become an unwitting victim. BrokerCheck, the SEC, and independent broker "watchdogs" can help you avoid some of these landmines before you enter into an advisor relationship.
2. If you even think your advisor churns, run!
Let me get this out of the way: The vast majority of investment advisors I know -- even the commissioned ones -- are well-intentioned. They mean to do the best for their customers -- but they often can't when their jobs depend on bulk sales. In this environment, the customer can't possibly come first, because advisors have to make a living for their families and themselves. It's how investment firms game the system.
Experienced pros sell lots of investments to sustain a high standard of living. Critics call it "churn," and industry salespeople call it "turnover." The more they sell, the more commissions they earn and the more their investment firms make. For example, a $300,000 portfolio turned over once a year would have a churn of 1x. If advisors want more commissions, they may double the churn to 2x. High turnover is not usually good for investors, and turnover of less than 30% (which is about 1x over three years) is reasonable for older or more conservative investors.
But turnover is the lifeblood of brokers, and it's an absolute necessity for new representatives. That's because new advisors live on the edge and on the phone, qualifying and cold-calling prospects for pure survival. I know this because I was at both ends of the spectrum during a 25-year career starting at Drexel Burnham Lambert, where I began by making 300-plus phone calls a day. Today, Drexel is history, but their model of pushing advisors to "sell, sell, sell" continues today. Turnover creates commissions, though it may not be in investors' best interests. Investment firms win.
3. Fee-only advisors aren't a cure-all
Right now, some of you are probably asking, "So what?"
Maybe you invest on your own or subscribe to a Motley Fool newsletter, in which case this isn't a big deal. If you work with a fee-only advisor, it may not be as big of a deal -- but you should still have questions.
Fee-only advisors earn a living by charging a flat or hourly rate, which is pretty straightforward. Or they charge a percentage of the assets they manage, which is a bit murkier. Where is their incentive to give your portfolio the attention it needs? Can your fee-only advisor tack on extra sales charges? Are they compensated in any other way? You still need to find the answers to these questions for a mutually beneficial relationship.
4. Advisors don't have to tell you squat when they switch firms
FINRA recently withdrew a proposed rule that would have required investment reps to disclose signing bonuses and other compensation they get for switching firms.
Investment firms pay big dollars -- sometimes in the seven figures -- to attract advisors from competing firms. For this money, advisors are expected to bring clients with them. As you can imagine, investment advisors switch firms a lot.
So what's in it for you?
Maybe moving with your advisor gives you new investment opportunities -- perhaps greater fund choices than your old investment firm had. Maybe the move hurts you, because you can't transfer certain products or funds. Further, your advisor and you will have to complete and file tons of transfer papers to move your assets. And who's to say your advisor will pay the necessary attention to your portfolio when he or she is focused on the move and all the attendant complications?
Whatever the case, your advisor won't tell you to leave your money with his old firm, even if that company is best for you. Nope, you'll hear about all the bells and whistles that come with the new firm. You won't get any transparency about the move, although FINRA plans to revive a proposal on this subject later this year.
Expect this proposal to get continued pushback from the industry. But if your advisor switches firms, don't expect a full accounting of the finances behind the move. It's not required, so it's probably not happening.
It's ultimately up to you
If you're a Fool, you probably take more interest in your investments than the average Joe or Jen. If I could offer one piece of advice, it's this: Put that same interest into how much your investment advisor is making -- or losing -- for you. Do your due diligence or find a firm that will help you see through the industry's long-established smokescreen to make sure your advisor is right for you.