Dispensing Adviser Advice While Eating A Tuna Melt

8683395_sI love a good tuna melt. You know, the kind that falls apart as you’re trying to wolf it down before anyone notices you are eating like an animal. There is this new deli in town located diagonally across from my office, called Prime Cut, and they have the best tuna melt I have ever tasted. I think they purposely put it on the specials board each day to see how many times in a row the poor slob from across the street will order it. So far it is seven and counting…
Anyway, I was there last Friday eating my tuna melt when this elderly gentleman approached me. He recognized me because he reads this weekly column. He is from New York and has a summer house on Eel River. Ken asked me if there is anything that his financial adviser doesn’t want him to know. I offered for him to join me if he could stand watching me make a mess of my tuna melt.
I explained to him that ideally, financial advisers should be working together with their clients, for their best interests, and therefore should not have any secrets, or be withholding information. Nevertheless, I explained that it is not always the case. I am going to throw a wide net here; in my opinion there are a few things that some financial advisers, but not all, avoid discussing. Here are a few that I told Ken he should be aware of.
First, most investors retain a financial adviser for help building an investment portfolio. They assume that because the adviser’s business card or name on the door says financial adviser, he or she is an investment expert.
Caution: In many cases, financial advisors are primarily relationship managers. They manage their relationship with the client; they answer client calls, and recommend and sell products.
In such a case, the adviser’s primary job is to acquire new assets and to build a book of business. Often their job performance is not judged by the performance of their recommended investments, but by how many new clients and assets they bring to their company. I explained to Ken that this rolls into an important distinction between two standards in the world of financial advice, suitability vs. fiduciary. I asked Ken if he knows that brokers are under no obligation to suggest investment vehicles that are in their clients’ best interest. By regulation they only need to recommend “suitable” products based on a couple of factors, primarily their clients’ age and risk tolerance.
An Investment Adviser Representative (IAR), on the other hand, is legally required to act in a fiduciary capacity and must make recommendations based only on a client’s best interest. Although an individual can be dually licensed as both a broker and an IAR, such an individual is only held to the fiduciary standard if his or her investment advice is “incidental” to his or her practice.
I suggested to Ken that he ask his financial adviser if he or she is bound by law to act in a fiduciary capacity. I also suggested that he evaluate his portfolio during down years, like 2008. If he lost, his first question should be, why? He should ask if his adviser has changed strategies to lessen the possibility of it happening again. If an adviser is working in a client’s best interests, then wouldn’t such a change be expected? Why should he have to ask, right?
I also told Ken that he should be aware of compounding fees. Most investors pay a fee for advice and they assume that is all they are paying. Caution.
If an investor owns mutual funds, for example, he or she is likely paying Asset Based Sales Charges (ABSC), and most investors do not even know it. I explained to Ken that these are fees he would not pay directly, but which are taken out of a mutual fund’s assets to pay to market and distribute its shares. For example, ABSCs can be used to compensate a broker for the sale of mutual fund shares, for advertisements and to print copies of the prospectus. ABSCs include Rule 12b-1 fees, which are dedicated to these types of distribution costs and can range anywhere from 1 to 2.5 percent per year. This is usually in addition to the advisory fee, referred to as a “wrap fee.”
In 2011, the SEC began requiring firms to publish the “Form ADV Part II” explaining advisers’ compensation in plain English. It explains whether your adviser is paid a commission from selling investment strategies, charges a flat fee, or is paid in other ways. I advised Ken to request the ADV Form and to have his adviser walk him through it so Ken understands all of the fees.
I also told Ken that there are other important things, in addition to portfolio composition, that he should ask his financial adviser about. A sound financial plan includes strategizing for taxes, income planning, insurance needs, estate planning and more.
Lastly, I explained to Ken that the key to success is to not always focus on getting the highest possible return. It is to understand how you define wealth at each stage of your life. Real financial planning goes far beyond a colored pie chart illustrating a “diversified” portfolio. It’s about the hard conversations. Are you saving enough? Are you spending too much? Are you budgeting properly? Are you assuming too much risk? Are you avoiding market losses?
I enjoyed my time with Ken. In the end, I reassured him that the financial services industry is highly regulated. And there are good, even great, advisers out there working every day in their clients’ best interests. But it is always important to know the questions to ask a financial adviser.
I will be back at Prime Cut tomorrow going for number 8. If I keep up this pace, I will be known as Charlie, the StarKist advisor.
Be vigilant and stay alert, because you deserve more.