Recently, there’s been so much press attention on a working paper published by the National Economic Bureau of Research. The paper concludes that retail financial advisors tend to choose investments that will maximize their fees, particularly actively managed investments with higher expected fees. I argue that their methodology was flawed.
I was speaking with Philip Palaveev, president of Fusion Advisor Network, recently about a separate topic, but something he said brought me back to this working paper: “The conflict is not really between different methods of compensation. It’s really between putting clients’ interests first as a culture and a mentality.”
I tend to agree with him, but many publications have been reporting on the conclusions and taking the academics’ word for it. But the research is still in progress. The point of such working papers is for the academic community to comment on the initial findings, and the authors will take those comments into consideration in preparing the final papers.
Like I said before, there may be a few bad apples, but that happens in every. With financial advisors, I believe you can’t define them by how they’re getting paid; it’s their ethical behavior that matters. And most will end up putting clients’ interests first, commission or not. Palaveev puts it much more eloquently:
You know how they say culture is what they say when nobody is watching? So the real question is not what happens when people are watching; the real question is what happens when nobody’s watching. And I think that’s where advisors either have that mentality or they don’t. If they put their clients’ interests first and they have that mentality, whether or not they’re registered and what the fiduciary standard means to them is a secondary question…
Most advisors inalready have that mentality that they care deeply about the client and they’re focused on what the client needs. I don’t think the method of compensation determines that. Does your doctor treat you any different when you pay with an insurance versus when you pay with a credit card? The method of compensation does not create the relationship. It creates the potential, but that potential is not always realized. It’s up to the professional to determine how they behave. If somebody drops their wallet on the ground, and the next person who sees it, there’s the potential for that person to pocket it, or there’s the potential for them to return it. But the decision is up to whoever finds the wallet. Their ethical behavior is not regulated by what they can gain or lose from it. It’s regulated by what they believe is right and what’s wrong. Otherwise we can say, ‘everyone who finds a wallet on the street is going to put it in their pocket because potentially they can gain from it’… The vast majority of people would actually return it because they do what’s right.
If we want to pursue this argument all the way to the extreme, no investment advisor would ever recommend that you don’t invest because they’re never getting paid if they recommend that you don’t invest… But advisors don’t take that extreme.
Do you agree?