For decades the financial advice industry has been dominated by advisors selling products for a commission. Even today most financial advisors are partially or fully compensated through product-based commissions. Meaning they get paid more when they sell more.
When it comes to a commission-based compensation structure, we can very quickly see how the interests of the client and the advisor are not always aligned. This compensation model essentially cultivates the mentality that the advisor is a hammer, and everyone else is a nail. It narrows the advisor’s thinking to providing a single point solution, as opposed to thinking about the suitability of a product relative to the client’s overall financial situation. The underlying incentive to sell is far from optimal for both parties, but most especially for the client.
Advisor Overload
Let’s say you’ve recently retired and want to learn about retirement income streams. It’s a lovely day outside so you decide to walk over to your financial advisor’s office. After a few blocks you stroll into the office where he assures you that a laddered bond portfolio is the absolute best, and only way to go. Perfect! The bond portfolio he described makes sense, and you’re on your merry way out the door.
Being such a nice day, and the meticulous investor that you are, you decide to walk up a block to hear what a competing advisor has to say. Upon arrival, she assures you that her institution’s high dividend stock portfolio will not only get you the income you’re looking for, but will also offer significant growth making it far and away the best choice for you. Now slightly confused and agitated by the competing information, you decide that despite the afternoon heat setting in, this warrants further investigation.
You walk a bit further to visit your trusted longtime insurance agent hoping he can help you make sense of these competing offers. Distraught and dehydrated, you arrive at your agent’s office. He greets you with a much needed cold bottle of water, and shows you into his office. After describing the two previous encounters, your agent leans back in his chair thinking silently. After about a minute he leans forward. He begins by assuring you that neither of these two options can compete with his firm’s lifetime income annuity. Your head begins to spin. Your leisurely retirement stroll has now turned into a financial planning fiasco.
Know Who You're Talking To
Despite whether each of these hypothetical advisors were working on commission or not, the takeaway is that they were thinking in terms of products. As an unfamiliar consumer you can see how any of these could be a good option, but most of the time you will lack the expertise to know which one is truly the best fit for you. This is where we begin to cross into the realm of financial planning.
The role of a financial planner in a situation like this is to present the client with all of the available options, lay out the pro’s and con’s for each, and help determine the best course of action based on the client’s unique circumstances and preferences. For example, in the scenario above a financial planner would likely show you the projected future cash flows for each of the three options, while also providing an explanation on the associated risk and fees for each one.
The core difference between planning and products is that planning is comprehensive and unbiased. True financial planning is fee-based, meaning compensation is based on a flat-fee, as opposed to commissions. With the elimination of commission-based compensation, planners can act as an unbiased guide for their clients while navigating a set of financial products and strategies. Not only that, but a good financial planner should be the one proactively bringing you different options and strategies. That way you can skip the frustration, dehydration, and multiple advisor visits.
The bottom line is that it’s crucially important to understand whether the advisor sitting across from you is trying to sell you a product or actually giving true financial planning advice. Most of the time this question can be answered by determining how the advisor is being paid. By understanding the underlying incentives and compensation structure for a given advisor, you will be better equipped to separate products vs. planning advice.
