Are You Getting Bad Financial Advice for Your Life Savings?
Advice and recommendations – there is a huge difference between these two words.
In our everyday lives, the words “advice” and “recommendation” are often used interchangeably as a “suggestion or proposal put forward by a knowledgeable or authoritative person.” However, when it comes to financial planning and the health of your investments and life savings, there’s actually a huge difference! And that difference depends on whether the suggestion is coming from a broker/salesman or a real financial advisor.
The difference in most people’s minds is that advice is usually not welcomed unless it has been solicited, while most people are willing to accept a recommendation from someone with knowledge or experience in a matter of interest to them.
However, when it comes to your future financial security, knowing the difference between advice and a recommendation is critically important because they can produce markedly different outcomes.
Advice Comes From Unbiased Experts
We seek advice from our doctors and attorneys or other experts from whom we can expect to receive objective guidance on matters of importance. Because such advice is typically based on an in-depth study of an individual’s situation and dispensed with the individual’s best interests in mind, it is usually followed without question.
Recommendations Come From Salespeople
When we go to the store to buy a TV or computer, we often welcome the recommendations of a salesperson because they should have more knowledge about the products we want. They do their best to learn about our preferences and explain why one product might better meet our needs than another. We hope they are unbiased; however, it’s very possible the salesperson is driven by incentives to promote one product over another and he or she is likely to earn more commissions for selling a more expensive product along with accessories.
In the financial services industry, the theory is the same but the sales pitch can be trickier to catch. And in this situation, the recommendation could be bad financial advice.
Recommendations are Often Cloaked as Advice (Salespeople are Often Cloaked as Advisors)
When it comes to financial advice, we expect – or at least hope – that the guidance we receive is objective and free of any conflicts of interest. But, very often, the distinction between advice and recommendations is muddled, leaving investors to discern.
The good news is there is actually a legal distinction between advice, which is required to be unbiased and in the best interests of the client, and a product recommendation, which only needs to be reasonable and suitable in light of a client’s situation.
The bad news is you really don’t know which you are getting unless you know which type of financial advisor is providing it. The challenge for investors is there are more than 600,000 financial professionals who call themselves a “financial advisor,” “investment advisor,” financial consultant” or some other title that implies an authentic advisory relationship. However, 90 percent of these “advisors” are really nothing more than salespeople who are licensed to sell investment products as registered representatives.
They might work for a brokerage firm, an insurance company or an independent broker-dealer. Under regulatory rules, they are not allowed to offer investment advice – they can only make product recommendations. Essentially, they are paid to sell investment products; not provide advice.
Advice and Recommendations Come with Different Standards of Care
The Suitability Standard of Care
Recommendations must be based on reasonable grounds that the product is suitable for the client. But, it doesn’t necessarily mean the recommendation must be in the best interest of the client. For example, an advisor can recommend a certain mutual fund based on its suitability for the client, but it may not be the lowest cost alternative. But that’s acceptable if the advisor can show that it is suitable.
Registered representatives are generally commission-based salespeople, which means they don’t make money when they make a product recommendation; only when they sell a product. They may earn higher commissions, a larger payout or a bonus for selling certain products on their broker-dealer’s product platform, which puts them completely at odds with your best interests. And they are not even required to disclose how much they or their firm earn from the sale of a product. Once they sell you a product, they are not required to provide any ongoing advice or guidance with respect to the product or how it is performing.
You can see how this may lead to bad financial advice.
The Fiduciary Standard of Care
There is only one type of financial advisor who is required to provide objective, conflict-free advice in a fiduciary capacity – Registered Investment Advisors (RIAs) who register with the Securities and Exchange Commission (SEC). As fiduciaries, RIAs don’t sell investment products for a commission. They are paid a fee directly by their clients, which allows them to put their clients’ interests first. Unlike commission-based financial advisors, RIAs are required to fully disclose how they are compensated.
You Wouldn’t Seek Dietary Advice from a Butcher
You go to a butcher because you expect him or her to sell you a quality piece of meat. However, you wouldn’t or shouldn’t expect the butcher to send you to a fish market because fish is a healthier choice for your diet. That would be the job of a dietician, who is knowledgeable about such things and is trained to dispense advice based on your dietary needs.
For the same reason you wouldn’t seek dietary advice from a butcher because he or she obviously has a bias toward meat, you shouldn’t seek financial advice from a stockbroker because he or she has a bias toward certain types of investment products. This can lead to bad financial advice.
If you go to an insurance agent, you can expect to be sold life insurance or an annuity. If you go to a bank, you should expect to be sold bank products because that is what they are paid to do. If you seek unbiased, conflict-free financial advice, you go to a fiduciary financial advisor because that is what they are paid to do.
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