What Is The Most Important Question You Will Ever Ask Your Adviser?
It may not be, when can I retire? Or where should I invest? Or how much insurance do I need? Or should we pay off our debt first before investing? Or any other question related to your financial situation.
These are important questions to be sure. But maybe the most important question is “How do the decisions that I make on what I do with my money affect your income?” Your adviser’s response should be revealing.
When you seek out an adviser for investment or planning assistance, you typically expect guidance and recommendations. And you expect that the recommendations are made in YOUR best interest, right? Let’s be clear – you should have the expectation that the advice you receive is not compromised. Unfortunately in far too many cases adviser compensation trumps your best interest. Look at these two common examples of how this happens:
First, consider a 65 year old retiree that is evaluating how to take their workplace pension plan. This is a huge decision and they want to make the right choice. It would be wise to seek out a second opinion from a professional. Let’s say that the pension provides an annual income of $35,000 along with a survivor benefit at 75%. Their other option might be to lump sum the pension and transfer it to an IRA. Let’s say that the lump sum value is $375,000.
What might/should the adviser recommend? Well, what is best for the client is dependent upon many factors. Maybe they already have a lot of fixed income; maybe they are single; maybe they don’t really need the monthly income (for whatever reason); maybe they are comfortable with investments and want to try and increase their returns over time; maybe they want to ensure that their heirs receive a portion of their funds; etc. There will be many factors that could impact how they determine if the pension or lump sum transfer makes the most sense.
Yet how their adviser is compensated would have a huge impact on their recommendations to this client. A pension plan lump sum transfer can be a financial bonanza for an adviser. In this case, the adviser, if a broker/dealer, could recommend loaded mutual funds and they might make $8,000 or so. Or, if they have an insurance license, they could recommend an annuity that pays 4% and they might make $15,000 on the purchase of the annuity. Or, if they are a Registered Investment Adviser they could recommend a managed investment program that pays them 1% a year. That would be $3,750 a year in income, each year (and more as the account grows).
How likely it is that the adviser might recommend that the client take the pension if they literally make nothing at all? They would sacrifice quite a pay day. Sure it could happen but it’s asking a lot. If they want to get paid, the adviser is clearly going to be motivated to promote the features of their option over the benefits of the pension.
Our second example involves smaller numbers but is a typical scenario. What if a 30 year old wants to know whether or not they would be better off, on one hand, investing in a Roth IRA or a cash value life insurance policy (I am not a fan of this, but people do it), or, on the other hand, paying off college debt or their home? If their adviser makes no income by recommending that they pay off the debt, then they could very well promote the benefits of additional investments in the Roth or life insurance.
In both of these examples, and so many more, the advisers’s interest (compensation) could clearly compromise their ability to provide guidance in the best interest of the client. Of course in both of these cases it is very possible that the best decision for the client is to select the option that compensates the adviser. That is not out of the question. But there is also no question that advisers that only get paid if their clients use their investments are incentivized to frame the benefits of those options in the best light.
So how do you handle this? The key is to remember that this could be the most important question you will ask your adviser! Require that they list out all of their recommendations (should just be a couple) and how much compensation they receive for each one. This is something you deserve to know and they need to provide!