Minimizing Conflicts of Interest Matters
At Flat Fee Portfolios we believe that identifying and minimizing conflicts of interest matters. The financial services industry is littered with real and potential conflicts, many of which have been well documented. In personal finance, most sources of conflict stem from compensation arrangements that misalign the interests of investors and their advisors. Investors should understand how compensation arrangements influence the recommendations they receive.
Understanding Compensation Arrangements
Your advisor’s compensation arrangement can be fee-based or commission-based or, in some cases, a combination of the two.
Under a commission-based model your advisor receives compensation for selling you an investment product. The actual amount of compensation may be transparent (such as a commission for a stock trade) or opaque (such as a 12b-1 fee built into a mutual fund). However it is charged, a commission based arrangement is clearly conflicted because the advisor is only obligated to meet a suitability standard. This means their advice and recommendations only have to be appropriate. An advisor that takes a commission may be acting in your best interest, but they’re not obligated to do so, as they would be under a fiduciary standard.
Under a fee-based model your financial advisor is compensated by you directly for advising your investment portfolio. Typically this takes the form of an AUM fee described in our Fees Matter section. By its nature, this is more objective than a commission-based approach because the fiduciary standard applies. The goal is not to sell you on a particular product, but there are still conflicts inherent in this relationship. With an asset based fee, the investment advisor’s incentive is to maximize the amount of assets under his or her management. For example, if you ask an advisor for advice on whether or not to pay down a mortgage, this is a decision which would reduce an advisor’s assets under management and could cost an advisor thousands of dollars in lost fees every year going forward. Conflicts could also come in the form of recommendations to consolidate everything with the advisor, the rationale for the recommendation being convenience or better service. This may or may not be ideal for the investor. In practice, some common recommendations involve rolling over an old 401k that has an attractive stable value option or surrendering a fixed annuity paying an above market rate of interest.
A Flat Fee Relationship
A few investment advisors, like Flat Fee Portfolios, charge a fixed flat fee. We believe this to be the least conflicted method of charging for investment advice. The reason for this is simple. We act as fiduciaries and our compensation is not tied to any specific product or the amount of investable assets that are held with us. Our goal is to have our clients satisfied with our advice and our service. Thus we can provide objective, unbiased investment advice centered on our clients’ goals and objectives.
The compensation arrangement by itself isn’t enough to help you determine whether the advice you’re receiving is appropriate, as it is merely the incentive structure. Understanding the incentives will help shape the framework with which you assess the quality of the advice you’re receiving.