How Independence Can Protect Your Portfolio

Published: 09th November 2010
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Times have changed - and so have financial advisors. Many people question the increase in federal regulation in general and specifically in the financial & banking sectors, yet recent accounts of the business practices of several companies, most notably Goldman Sachs, have raised intense questions for clients' about the relationship with their advisor. Today, people don't want financial advice from a salesman. Instead, they want a relationship with a financial professional who is trustworthy, thoroughly educated, candid, and who provides "un-conflicted" personalized financial consulting for each client.

That search often leads them to a fee-based or fee-only financial advisor or a Registered Investment Advisor.

A reassuring alternative to Wall Street. A paradigm shift is happening, and the traditional brokerages and other large institutions that provide financial services are lagging. While old-school "stock brokers" have gone the way of the wooly mammoth, you still have a sales-first mentality in place at big banks, Wall Street brokerages and insurance companies. If you're employed by one of them, the mantra is simple: make a sale, and earn a commission also known as "eat what you kill".

As they try to serve their clients, these "brokers" or financial advisors regularly are placed in a compromised position as they contend with sales quotas and the inherent potential for conflicts of interest. It wears on them: a 2010 survey revealed that only 15% were "very satisfied" at their firms and another 20% wanted to leave within two years.1 The recent legal settlement between Wall Street's premiere financial company Goldman Sachs and the SEC, where Goldman paid a record $550 million penalty for its "mistake" by providing clients with "incomplete information in marketing material" (Goldman's words) is an example of these potential conflicts.4 The significance of this case, besides the dollar amount of the settlement, was that the "mistake" involved clients purchasing a product which Goldman sold for a commission. Goldman neglected to tell the purchasers that another party helped design the product and benefited if the product were to decline in value! Oh, and the other party, John Paulson, allegedly made as much as $1 billion from the decline in value of the product he helped design for Goldman.5

Given the tarnished reputations of so many giant banks and brokerages, it isn't surprising that consumers are turning elsewhere for financial advice. Here are three popular destinations.

A fee-based financial advisor is structured to promote earning income from fees for managing clients' investments instead of commissions on selling specific products. There is more of an emphasis on advice than traditional brokers, however these financial advisors may still derive significant compensation from the sale of annuities, life, disability, or other types of insurance products with high commissions.

Fee-only financial advisors earn no commissions at all. They derive 100% of their income from client fees, annual management fees, or hourly or per-project consulting fees. With this compensation arrangement, you know that a fee-only advisor is available to help you address myriad issues in your financial life, not simply those that could lead to a commission.

A Registered Investment Advisor (RIA) usually works to manage the assets of high net worth investors. An RIA receives management fees and does not receive commissions. The management fees usually represent a percentage of the assets a client has invested. Additionally, as a part of the consultative nature of the client relationship, annual retainer or per-project financial planning fees may be included as well. RIAs have to register with the Securities and Exchange Commission and any states in which they operate.2 They also are required to conduct business with their clients on a fiduciary basis, which simply means that they place the best interest of the client above the firm's interest at all times. Individuals, couples, families, businesses, and institutions with wealth management concerns often turn toward RIAs.

Even as the market has struggled since the end of 2007, independent Registered Investment Advisors have gained a greater share of assets under management in the U.S.3

People need unbiased advice. An independent, fee-only financial advisor or RIA also has freedom - freedom to choose the most appropriate products and services for your risk tolerance and investment goals. That's probably the #1 reason why people and institutions seek an independent financial advisor. They know that the advice they receive is not influenced by sales incentives or directives. There is often a candor to the discussion that may not always be present at a bank or a brokerage.

People want more investment choices. An independent financial advisor is free to offer ideas and investment options from every available company, rather the investments of a single company who is often their employer. In addition, that independent advisor can unhesitatingly tell you if an investment is or isn't appropriate for your financial situation.

This is the age of independence. When it comes to the financial future, no one wants to be "sold" - just advised. Thus the SEC is in the process of making a decision if all firms and their financial advisors must conduct business as fiduciaries whenever they seek to provide "advice" to their clients. Because after our experiences during the Tech bubble, corporate fraud scandals (Enron, WorldCom, Tyco, etc.), real estate bubble, great recession, and of course the Madoff scandal, your right to demand for the kind of relationship where the financial
advisor puts the client relationship first.

Citations
1 - bankinvestmentconsultant.com/news/pirker-aite-wirehouse-advisors-2667209-1.html [6/1/10]
2 - investopedia.com/articles/financialcareers/06/whatisaRIA.asp [6/11/10]
3 - fa-mag.com/fa-news/5548-independents-make-headway-despite-downturn.html [5/10/10]
4- http://www.bloomberg.com/news/2010-07-20/goldman-sachs-settlement-with-sec-for-550-million-approved-by-u-s-judge.html [7/21/10]
5- http://money.cnn.com/2010/04/16/news/companies/SEC_goldman_paulson.fortune/ [4/16/10]

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