Thursday, October 17, 2013

How is your advisor making money?

If there’s one common denominator that links many Wade Financial Group clients, it’s that they came to us as a result of another person—sometimes a financial advisor, sometimes not—who gave them bad advice...and occasionally that person profited from the deal.

Recently we met with a person who had had just that experience. He and his wife had been working with a family friend as an advisor, who had sold them an annuity for his IRA.

Now, that just doesn’t make sense on the face of it. The advantage of an annuity is that it’s tax-deferred…but the IRA is already tax-deferred. So, the couple was paying extra in fees for zero added advantage.  Meanwhile, the “family friend” made a nice fat commission on the sale of that annuity.

Another example: in the news, we’re seeing reports of some doctors and dentists who are suggesting financing arrangements to their patients. The patients, who trust their care providers and need the money for health procedures, accept it. Only later do they find out that they’re in the hands of a predatory lender. In the example quoted in The New York Times, the patient was paying 23 percent in annual interest, with a 33 percent penalty rate kicking in if she missed a payment!

While many doctors and dentists have rightly refused to participate in these financing arrangements, you can understand their motivation to work with these lenders: they get paid 100% upfront for their work. That’s a powerful motivation.

All of these point to a larger story that we see repeated all the time at Wade Financial Group: people get hurt financially by someone they trusted—maybe without understanding the incentives behind that person’s actions.

How can you avoid this?

At a basic level, you have to understand how the person who is advising you is making money. That’s why I strongly recommend that people work with a fee-only, fiduciary financial advisor, such as Wade Financial Group. Being “fee only” (not “fees plus commissions” or some other arrangement) means that the advisor is not making commissions based on what they recommend. Their compensation is tied to the overall wealth of the client—so they’re incentivized to act in the best interest of the client.

And as a fiduciary, the advisor is legally bound to act in the best interest of the client.

As a consumer, you should insist on transparency surrounding how the person you’re working with is being compensated. If they can’t tell you—or won’t—that should be an immediate red flag.

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