The Primary Conflict of Interest

As follow up to my post titled Conflicted Advice - Why Fee Only is Not Conflict Free, I thought it important to discuss one additional conflict of interest present for all financial planners and investment advisors. A comment on my previous post mentioned that I had not made my case because I had not covered all fee-only advisors. I agree with this commentor in many respects, so believe it important to discuss this additional conflict which I think will drive my point home. There is likely new criticism to be made about this post specifically because I contradict myself in many ways, but I think this helps make clear how complex this particular conflict of interest can be.

I imagine you will have never heard a financial planner or investment advisor state the following, but there exists one fundamental conflict of interest which all planners and advisors always bear and cannot eliminate. This conflict is so basic and so fundamental to the financial advisory business process that it is generally overlooked, even though frequently indirectly mentioned by clients. Clients touch on this conflict by asking a question similar to the following: "Have you made me more money than I have paid you?"

The Conflict

The financial advice industry finds itself in a very unique and difficult position. The value that many advisors profess to deliver is to help people protect and increase their wealth. However, in order for an advisor to deliver on this promise, a client first must be willing to give up a piece of that wealth in the form of a fee. An advisor's financial health requires that a client gives up a portion of their own financial health. This is an exceptional position to be in and creates a conflict of interest which will remain throughout any client/advisor relationship. Few, if any, other professions or industries must cope with this type of conflict. A doctor does not ask that you first pay for her services with a kidney or a portion of your good health. An attorney does not require you to shorten your life as payment in order to draft estate planning documents. A teacher does not ask that you pay for his lecture by turning over a portion of your IQ. But a financial advisor does ask that you turn over some of your money in order to improve your financial life.

With every service or product an individual must decide if the value received exceeds the price to be paid. If this were not the belief, no transaction would occur. The same is true when deciding whether to hire a financial advisor. But it is rare that the value and price be so closely tied... that the price immediately increases the value which needs to be delivered.

Understanding Value

How do you, as a consumer of financial advice, decide whether you are receiving adequate value and whether this conflict is impacting advice you are receiving? The answer depends on what you and your advisor set out for expectations from the onset of your relationship. What did they promise to deliver? If they stated that they would attempt to outperform the market, you could compare whether they have exceeded an appropriate index by more than what you have paid them. You could also simply compare if you made more money with your investments than you paid your advisor. This type of review is far too simplistic, however.

In fact, many advisors would not claim to be able to outperform the market with their investment platforms. Other advisors have relationships with clients which do not involve investment management at all and may only include portions of the financial planning process. And yet more advisors who do state they will outperform the market also provide many other services which they would point to as increasing the value delivered. Placing monetary value on these intangibles becomes exceedingly difficult, particularly as the layers of services increase.  How much do you value someone helping you become more aware of your cash flow and increasing your savings? What is the price tag for someone to help you articulate your best life and help you craft a path to live that life? What you pay the advisor is clear. There is a fee which they receive from you. But how they improve your financial situation and deliver more than the fee in return is not so easily determined. If your expectations about what is to be delivered in return for your giving up some financial health are not the same as the expectations of the advisor, the conflict grows and can become a significant problem in your relationship. These differing expectations can place you on opposite sides of the table from your advisor, creating an adversarial relationship where the advisor must continually prove his worth and prove that he has not, in fact, hurt your financial health in the process of improving his own.

Managing Expectations

Fortunately, keeping this conflict in check can be accomplished with clear communication about expectations early in the advisory relationship and frank assessment of delivery on those expectations throughout the relationship. Honesty and integrity sit at the heart of this communication. You, as the client, must be open about what you want from the relationship, and you must let your advisor know when they have exceeded or have fallen short of your expectations. The advisor must be forthright in their assessment about whether they are delivering the value they proposed to and whether they are meeting their own expectations. If they do not believe they are doing so, they must be willing to communicate this to you so that the relationship can be severed or new expectations can be agreed upon. None of this can happen unless these expectations are clearly articulated between you and your advisor.

The Silver Lining

Additionally, this conflict of interest has an opposite element for fee-only advisors. A fee-only advisor requires your continued agreement to pay their fees in order to maintain the income source your provide them. This can help place you back on the same side of the table with your advisor. If their advice were to send you into financial ruin, they would lose you as a paying client. If this happened to many of their clients, the advisor may find themselves in financial ruin. This provides the advisor incentive to give advice which should help you maintain the ability to pay their fee. This incentive may not help you reach your goals directly, but is should at minimum allow you to feel less discomfort about giving up some of what you hope to achieve by hiring a financial advisor.

Every financial advisor must work under this conflict of interest. In order for their business to survive and succeed, they require that you give up a portion of what they promise to deliver back to you. Only through a strong, open relationship with clearly established expectations can you feel comfortable that your advisor is acting first on your side of the conflict.  Be clear with your expectations and demand that your advisor be clear as well.  It may lead to a better advisory relationship or help you recognize you are not working with the right advisor.