10 things financial advisers won’t say

April 1, 2013, 7:38 p.m. EDT

10 things financial advisers won’t say

Pros will tell you where to put your money, but often at a steep price

By Ian Salisbury

1. “We’re your biggest advocate, except when we’re not.”

A consumer who seeks help from one of the nation’s 300,000-plus financial advisers is probably hoping to find (what else?) financial advice. Seems straightforward enough. But like anything where there’s a lot of money, and lawyers, involved, it’s not. For years, consumer groups and rival industry factions have battled — before Congress, the Securities and Exchange Commission and, of course, the press — over whether that “advice” should be required to be in the client’s best interest (the so-called fiduciary standard) or merely “suitable,” based on factors like age and risk tolerance.

Under current rules, advisers can adhere to either one of those ethical standards or both, depending on how clients pay for their services. The SEC has said it wants to hold all advisers to the tougher best-interest standard. Most consumer groups favor such a change, arguing that the looser “suitability” standard encourages advisers to steer clients into costlier products that’ll earn them fatter commissions. “They call themselves advisers, but they are functionally sales reps,” says Knut Rostad, founder of the Institute for the Fiduciary Standard, an investor-advocacy group. Video: 5 things financial advisers won’t tell you.

Advisers who favor the ostensibly looser standard say they have investors’ best interests at heart. One key contention: While the tougher ethical standard might eliminate some conflicts of interest, it would also boost costs by creating extra compliance work and additional legal liability for advisers. Groups like the National Association of Insurance and Financial Advisors argue that if all advisers were required to follow the fiduciary standard, many less wealthy clients — such as those with less than $250,000 to commit to markets — would simply turn away from financial advice altogether. “The fiduciary standard disenfranchises the middle market,” says Terry Headley, a financial adviser in La Vista, Neb., and the group’s former president.

2. “What we charge is all over the map.”

Just as many investors have trouble determining which advice they can rely on, many find it difficult to figure out how much they’re being charged. One big reason, consumer advocates say, is that advisers typically quote fees as an overall percentage of a clients’ wealth under management (1% a year deducted from your balance can seem abstract compared with a firm dollar figure like $10,000 a year). Another is that most investors never cut a check. Just like the checking account at your local bank, brokerage accounts overseen by financial advisers typically deduct customer fees automatically.

What investors pay varies widely, according to Mike Sha, chief executive of SigFig, a website that helps investors track fees and performance. At MarketWatch’s request, SigFig divided the investors that sign on to its service into cohorts ranked from those that pay the least to those that pay the most. The bottom fourth of its customers paid fees amounting to 0.47% of their savings each year, while the top fourth paid 1.39% — nearly three times as much. “A lot of people are paying thousands of dollars a year and have no idea what the fees are,” says Sha.

To be sure, some investors who pay more are likely receiving higher levels of service. Wealthy investors also typically are charged a smaller percentage of their assets, because economies of scale mean fixed costs don’t loom as large. Wealthy investors in Bank of America Merrill Lynch’s “Personal Advisor” program, for instance, pay fees of 2% on their first million dollars invested. But that falls to 1.1% for balances between $5 million and $10 million, according to regulatory filings. Merrill declined to comment on its pricing.

How can ordinary investors determine whether they’re paying too much? Starting in 2011, the SEC required firms to publish a document known as the “Form ADV Part II”; the information from that form enables investors to look up many advisers’ list prices on the SEC’s website, making it easier to comparison-shop. Another tip: While most advisers prefer to charge annual fees or commissions, a small but vocal number charge hourly fees or a flat dollar amount for a financial plan. Consumer advocates say this option can be cheaper for investors who don’t need ongoing advice.

3. “Your future looks bright, according to our software.”

The numbers convey the kind of certainty everyone wants to hear: You have a 98% chance of reaching your retirement goal, a 95% chance of paying your kids’ college bills — even a 94% chance of affording that summer house you’ve been eyeing. So it’s little wonder that financial plans that include these kinds of statistics — typically generated by software that combines inputs like age and savings rates with historical market returns — have become a favorite with advisers and clients alike. In 2012 advisers said they completed financial plans for about 59% of their clients, up from 46% in 2011, according to industry researcher Aite Group. “It helps put your goals into perspective,” says Aite Group research director Alois Pirker.

But critics warn that investors can put too much stock in these calculations, which are typically based on mathematical models known as “Monte Carlo” simulations—that’s Monte Carlo, as in the European gambling haven. The models are designed to calculate probabilities based on thousands of possible market scenarios. But equations are only as good as their inputs. That is a lesson many Wall Street whizzes learned during the financial crisis when similar complex mathematical models designed to value mortgage-backed securities went awry because of faulty assumptions about how many people would default on mortgages.

The take-away, according to some financial pros, is that while plans can be a useful tool, investors shouldn’t overlook the fact that someday they might lose their job or, for that matter, decide they’d rather sail around the world — scenarios that could of course render a preset plan obsolete. “There are some advisers who generate a 100-page report” — a plan for a client’s life — “without any judgment or wisdom,” says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. “That’s not adequate.”

4. “There’s no easy way to judge our stock-picking performance…”

For investing pros at hedge funds, endowments and mutual funds, success is defined by performance. Those who beat the market by a few tenths of a percentage point each year may be featured as celebrities on CNBC. But how does your financial adviser’s stock-picking ability stack up against the skills of star investment managers like David Swensen, who oversees Yale University’s endowment, or bond king Bill Gross?

While investing acumen has long been part of advisers’ sales pitch, substantiating the claim can be tough. First off, unlike mutual-fund managers, who can measure their performance against clearly defined benchmarks (the way, say, Gross’s Pimco Total Return Fund is compared with the Barclays U.S. Aggregate Bond Index), advisers’ mandates are more nebulous. Their job is to look after their clients’ overall well-being rather than some discrete segment of the securities markets. To that end, advisers say they set a variety of goals with each client, and clients can judge their performance based on how successfully they meet those goals. Furthermore, brokerages say they are constantly developing new tools to help investors track and measure individual portfolio balances. But because financial advisers work with so many different types of clients, it’s difficult to determine whether or not an adviser can “beat the market,” according to those in the industry. “We need to help each individual investor,” says the CFP Board’s Blayney.

Some research companies are working to get a handle on measuring advisers’ performance. In addition to tracking mutual funds, investment researcher Morningstar has been increasing coverage of “separate accounts,” customized portfolios of stocks and bonds that many financial advisers use for groups of their customers. Morningstar now follows more than 7,500 such accounts, 50% more than in 2007. Smaller players are also getting in on the act. Website SigFig, for instance, allows users to compare investment returns on their portfolio with others in the market or at the same brokerage, according to chief executive Sha. “We can audit your financial adviser’s decisions,” he says.

5. “…But we’re tops at raking in the dough.”

Investors cheered in January when Morgan Stanley’s Global Wealth Management group posted $221 million in pretax profit, a 12% bump from the previous quarter. The company’s stock jumped nearly 8%. One factor highlighted in the earnings report: Average annualized revenue per global representative jumped from $790,000 to $824,000. Clients might imagine this closely watched industry metric, known as “production,” indicates how much money the company’s 16,000-strong army of financial advisers made for them. Rather, it simply measures fees and commissions earned from them.

At brand name firms like Morgan Stanley, financial advisers typically take home 45% to 55% of their production. Those who work more independently often keep 90% to 95%, although these small-business people also have to pay to keep the lights on. Each year, small tweaks that top firms make to their compensation plans, known as “grids,” make big headlines in the trade press, as do career moves by top advisers looking for a slightly bigger payout.

To be sure, clients and advisers often make money at the same time. When an adviser picks winning investments, clients’ account balances and the adviser’s production increase in tandem. And sometimes investors can lower their bill by switching from a fee-based to a commission-based plan (many advisers will work either way). While commissions tend to mean investors pay more up front, in the long run they can work out to be cheaper.

Under either system, however, insiders say the fastest and surest way for advisers to boost their production numbers is simply to sign up more and wealthier clients — a dynamic that can emphasize salesmanship over investing prowess. “The advisers who gather assets boost production,” says Scott Smith, an analyst at brokerage-industry researcher Cerulli Associates. “They are the ones who get ahead” in the industry.

Not every adviser is reaching for the brass ring. Los Angeles-based adviser René Nourse left Morgan Stanley last year after more than a decade with that firm (and with Smith Barney premerger) amid what she describes as pressure to focus on wealthy investors that were more lucrative for the company. Working independently is “less of a grind,” she says. Morgan Stanley didn’t respond to requests for comment.

6. “We get paid by mutual-fund companies…”

Investors aren’t the only ones who pay fees to their financial advisers. Mutual-fund companies whose funds advisers recommend do too. Wall Street calls these financial relationships “revenue sharing.” While perfectly legal, critics have long likened the payments to kickbacks. “It is an obvious conflict,” says Rostad, the fiduciary standards advocate. “In most cases, the client has no idea it exists.”

Financial advisers don’t dispute that it’s a conflict of interest; disclosures often label it as such. Some pros argue, however, that since the vast majority of big mutual-fund companies make revenue-sharing payments, they don’t necessarily give brokers an incentive to pick one fund over another. What’s more, while many independent financial advisers don’t accept revenue-sharing arrangements, those professionals may charge higher upfront fees to make up for the lost revenue, according to Terry Headley, a former president of the National Association of Insurance and Financial Advisors.

Just how much money is at stake? Typically, firms don’t disclose precisely how much revenue they get from revenue sharing — for competitive reasons, they say. But Edward Jones, a St. Louis-based brokerage, is an exception. It is required to publish figures, as a result of a 2004 regulatory settlement over its disclosure practices with the SEC, New York Stock Exchange and National Association of Securities Dealers. According the company’s website, Edward Jones received $164 million in revenue-sharing payments from investment and insurance companies in 2012, amounting to about 30% of its $555 million profit. Edward Jones declined to comment.

7. “…And the loan departments of banks.”

Mutual-fund firms aren’t the only ones that dangle incentives to financial advisers in exchange for access to clients. Increasingly, Wall Street’s biggest banks have been encouraging financial advisers to help peddle banking products like mortgages, checking accounts and credit cards. Banks say the strategy, known as cross-selling, isn’t just about boosting their bottom lines. It is also a convenience for investors and allows advisers to focus on meeting the client’s broader financial-planning goals. “It is something our clients have told us they want,” says a Wells Fargo Advisors spokeswoman.

Not everyone is impressed, however. Critics point out that the sales incentives that these firms have added to advisers’ pay packages could create a conflict of interest, especially since they only apply to in-house products. In addition, regular investor protections such as the fiduciary standard, which are designed to cover securities, rather than banking products like loans, don’t necessarily apply. “The real question is, Are you getting the best deal?” says Barbara Roper, director of investor protection for the Consumer Federation of America. “The convenience of getting everything in one place comes with a price.”

8. “You read our disclosures, right?”

While most financial advisers face conflicts of interest of one kind or another, informing investors up front about them is supposed to make it OK in the eyes of law, according to experts like securities lawyer Philip A. Feigin. Does disclosure really work? “It is a Norman Rockwell view of what people really do,” he says.

In fact, the “important information” that you should “carefully” before opening a Merrill Lynch Personal Advisor account runs to 52 single-spaced pages. A similar version from Wells Fargo Advisors is 27 pages. In general, compliance experts say, big brokerage firms have the lengthiest disclosures because their size and multiple business lines mean they have both the broadest range of offerings for investors and the most potential conflicts of interest. Merrill declined to comment. A spokeswoman for Wells Fargo says the company is aware of the issue, and that it shares regulators’ goal of making disclosures more helpful to investors.

Many advisers are upfront in detailing for clients precisely how they get paid. Experts say investors shouldn’t be shy about demanding a clear explanation, especially regarding sales incentives and payments from investment companies like mutual funds. But those conversations can be awkward. And many investors don’t know enough about the industry to start asking the right questions. That is where disclosures ought to come in, according to consumer advocates and many industry insiders.

Ultimately, these documents do include a lot of valuable information, lawyers and other experts say. But it’s a mistake to assume potential conflicts like sales incentives and revenue sharing which regulators and consumer interest groups tend to focus on most will be emphasized or explained in detail, according to Louis Harvey, chief executive of Dalbar, a compliance consulting company. “The thing you care most about may be on page 7 in a little note,” he says.

9. “We put more initials after our names than crown princes do.”

Think HRH The Duke of Cambridge KG, KT sounds impressive? It should: Prince William is second in line for succession to the British throne, after all. But how about John Q. Adviser MBA, CFP, CFA, AIFA, CDFA?

Hoping to stand out before potential clients, many financial advisers can point to their impressively long list of credentials. The problem is, there are so many of these, even industry insiders joke that it’s difficult to tell them apart. One recent study by The Wall Street Journal identified more than 200 different designations for financial advisers, a number that appears to have climbed significantly in recent years. (The Financial Industry Regulatory Authority, or Finra, the self-regulatory organization for the brokerage industry, identifies 126 active designations, up from 81 in 2010.)

While some designations are designed to indicate expertise in niche areas like handling divorce or insurance, among the most commonly seen are the CFP, or certified financial planner (a credential for those that emphasize helping clients save and prepare for events like retirement) and CFA, or chartered financial analyst (for those that specialize in picking stocks and other investments). Both are widely respected, according to consumer advocates and industry insiders, for their in-depth training requirements. But consumers seeking the right advice have their work cut out for them. (For a comprehensive guide, see Alphabet Soup of Advice.)

Another problem with designation inflation is that easy-to-get credentials could be listed right alongside those that are tough to get, which could diminish the perceived value of the latter. Tom Robinson, managing director for education at the CFA Institute, a trade association for investment professionals, says students spend an average of about 300 hours studying for each of three exams needed to earn the group’s coveted designation. Only about one-fifth of those who start make it all the way through. But not every organization is as rigorous. For some credentials, “you can take a weekend course and get a designation,” he says.

10. “You want to sue us? That is so cute.”

Think your broker ripped you off? Investments are complex, and every year, thousands of Americans come to the conclusion that they’re being taken advantage of. But not everyone gets his or her day in court. Brokerage firms, like many other types of companies, typically require customers to agree to arbitration hearings. More than 4,000 arbitration cases are filed each year, according to Finra. (Regulators and other experts say such clauses are less common but growing among registered investment advisers, a separate segment of the industry overseen by the SEC.)

Finra, and the Securities Industry and Financial Markets Association (Sifma), a trade group that represents Wall Street firms, say the arbitration system is designed to save everyone time and money, and ultimately makes it easier for investors to pursue small claims. But industry experts have long raised questions about the process. “We have a lot of issues in terms of fairness and transparency,” says Heath Abshure, Arkansas Securities Commissioner and president of North American Securities Administrators Association, a group of state securities regulators. “It is the brokers watching the brokers.”

One big point of contention: Even so-called “public” arbitrators, included in panels to ensure nonindustry perspectives, often still have ties of one sort or another to Wall Street, such as experience as a securities lawyer. One recent study, by researchers at the University of Pennsylvania, the University of Michigan and New York University, found such arbitrators handed out smaller rewards on average than those with, say, a regulatory background. The effect was mitigated when investors brought a lawyer along to help argue their case.

Finra says most investors do hire a lawyer, and that those whose cases are too small to do so can get help through legal clinics that receive Finra-affiliated grants. The organization, which publishes statistics about arbitration results on its website, says it has also taken steps to make sure arbitrators are evenhanded. Since 2011, investors have been effectively able to demand hearing panels that exclude arbitrators with explicit industry ties. (Roughly half do so.) On a separate front, Finra has been trying to make it harder for those with marginal industry ties to qualify as public. “We’re constantly improving the forum,” says Linda Fienberg, Finra’s director of arbitration.