We all need advice from time to time. Sometimes that advice is about personal finances, Investing, borrowing, or maybe even how to play better pickleball. When choosing a source for your financial advice, stay away from financial advisors who have a conflict of interest. The advisor who makes money on your investment decisions is like the pharmaceutical rep who is telling you all about his new medication and why it is better than what you already use. The advice might be fine, but due to the obvious bias/conflict of interest, you never know when information is tipped in their favor.
When you read a study about a new wonder drug and notice the manufacturer financed it, you tend to take the information with a grain of salt. Use the same skepticism with your financial advisors. Follow the money and pay special attention to how your advisor gets paid. Every advisor needs to make a living, but they don’t need to make their living by pointing you toward decisions that will line their pocket more fully. Many a doctor has dropped his financial advisor after discovering the advisor was making more money off the portfolio than the doctor was.
Let’s take a look at who is offering us advice, and let’s consider what happens if we were seeking advice about paying off our home mortgage early.
The banker: If the bank holds our mortgage, they will continue to make a profit as long as we keep the mortgage and continue to pay them interest. If the bank sells their mortgages, they make money by writing new loans (points, loan origination fee, and setup fees), so they would profit if we were to refinance to harvest some equity. If a competing bank holds the mortgage, then any money sent to the other bank to pay off that mortgage will not be available to deposit in a savings account or certificate of deposit in the advisor’s bank, which the banker could loan out to make even more money. She is biased and has no reason to encourage us to pay off our houses. She makes no profit when we pay off a house.
Stockbroker: A commissioned broker only makes money when we buy or sell stock. The more he can convince us to churn our account, the more money he makes. If we were to use our available cash to pay off a mortgage, that money will not be available to buy more stock and generate additional fees. He is biased and has no reason to encourage anyone to pay off their house.
Insurance salesperson: Many of the insurance products they peddle are great for the insurance company and the salesperson’s commission but are bad for the buyer. This is true for any kind of life insurance that is also an investment. Commissions come directly out of our pocket and are not available for the investment. Like the other listed advisors, if we use our available cash to pay off the mortgage, it will not be available to buy the overpriced, high-commission policy the salesperson wants to sell. (Only buy term life insurance and never use insurance as an investment.) He is biased and has no reason to encourage anyone to pay off a house.
Advisor paid on total portfolio value (Assets Under Management or AUM): Some advisors are paid a percentage of our total portfolio value. The larger the balance in our investment account, the larger the advisor’s paycheck. If we use any money to pay off our house, it is not in our portfolio to raise her income. She is biased and has no reason to encourage us to pay off our houses.
Accountant: Many accountants are really tax preparers in disguise. You do need to have a top-notch accountant/CPA, not simply a tax preparer. Tax preparers may not be after what is best for us overall, but rather what creates the most deductions. The more tax deductions they can put on our tax return, the more it looks like they are earning their fee. “See what I did for you.” Unfortunately, the things that create the most deductions are not always the best options. The home mortgage interest deduction, if you are one of the rare people who can actually get this deduction, is rarely the best deal.
Deductions are good, but only if we had to spend the money anyway. Remember, the reason we can claim a deduction is because we’ve lost money. To lose one dollar in interest and gain 24 cents in tax refund is not a good deal by itself. To get the 24-cent refund for something we already had to pay anyway is a better deal. We don’t have to pay mortgage interest. If we didn’t have anything to deduct, we might not need someone to prepare our taxes. An accountant is less biased than the others, but has no motivation to encourage anyone to pay off their house.
Unbiased advisor: An unbiased advisor will not be selling anything or making any profit based on the decisions we make or the size of our portfolio. This person has our best interests in mind. If we do well, we tell our friends, and she gets more clients. She has no biases to keep her from recommending we pay off our mortgage, if it’s in our best interest. This is the financial planner who is paid a fee for her time, not a commission or percentage of anything she might be selling. This is the advisor we need to find.
Except for the unbiased advisor, the preceding examples are often salespeople masquerading as financial planners. They often have minimal training in financial advising and maximal training in selling their products. They have their own best interests in mind and if they can help us along the way, that’s a bonus. Some are legitimately trying to help us, but only inasmuch as it helps them also.
When I first set up my IRA during my internship, I went to an investment firm. The advisor helped me set up my IRA. The mutual fund he recommended had the highest front-end load allowable by law. In other words, it was the investment option making him the most money. He was only steering me to the investments that were lucrative for him. If he was not going to make a commission, it didn’t matter how good the investment was, it was not on the table and I would never hear about it.
Ask your friends who they use for financial advice, why they like the person and if they can recommend them for you. Finding good advisers is key to your financial future. You will need several different types of advisors through the years. The one who helps you set up your 401(k) plan might be different than the one you use to negotiate a contract.
For those of you who might need it, I offer a financial makeover program to help you get all the pieces of your financial life squared away. Since I don’t manage any money, I have no possible source of commission. If what you are seeking at this time in your life is to get your personal finances in good working order so you can reach all your financial goals, this would be a good program for you and you can contact me if you want to check into it.
If you feel you need help with managing your investments, you can pick someone from my recommended flat fee investment advisor list. When considering an advisor, always follow the money and see how he or she gets paid. If it looks unbiased and they come with good references, you are likely to be happy with the results.
thank you for your article.
Gina your intuition is correct. It is a very rare physician who can benefit from any cash value life insurance plan. But term insurance and invest the difference between the price of your current plan and the new term insurance. You will have a lot more money in your “cash” account that way and if you die you can have both your investment account and the life insurance money. But the deal you have now, you get the life insurance money but they get to keep your Cash account.