This Reader’s Digest article does a good job summarizing some key things to remember when dealing with people in the financial services industry.
Reader’s Digest adds a few more thoughts in this separate article.
Many of the points we have discussed previously.
A few quick comments from my side:
Conduct Proper Due Diligence When Choosing an Advisor
All advisors seem to be a member of some organization or has some type of certification.
Learn and understand the professional credentials of those offering you financial services.
Do they have ethical standards and regulations that ensure they will act in your best interest? Knowing how your advisor should operate may provide you with some comfort in your dealings.
Note that I wrote “should” and “may.” There are many examples of strongly credentialed financial advisors who did not meet their responsibilities to their clients. Never blindly assume that you are protected because your advisor is a member of an organization with defined standards.
As for the comment about advisors not bilking smaller accounts, I would not agree with that statement. I have seen many examples of small investors hurt by the actions of negligent or criminal financial employees.
What to Do
Do your due diligence before choosing a financial advisor.
Get recommendations from trusted friends and associates to assess service quality.
Determine the advisor’s technical expertise and experience.
Find out if the individual is a member of an organization that requires strict ethical practices.
Assess the reputation of the company for which the individual works? If there are problems, will the company provide assistance to the client?
Financial Products are Products
Some people that I speak with have a different perspective on financial products versus other products such as autos, houses, or major appliances.
If one decides to buy a new car, he is on guard for the stereotypical shady car dealer. The buyer believes that the car dealer has monthly sales quotas, wins prizes for high sales volume, earns higher margins for accessories and upgrades. As a result, many car buyers are suspicious and do plenty of homework before stepping onto the auto lot.
But the same is true for many financial organizations. These companies are in business to make money. And they make money by selling financial products and services.
Employees are often rewarded based on sales performance.
Advisors may earn money in sales commissions or loads from certain products. That may lead them to push higher paying products over those with lower commissions.
It may also cause advisors to try and churn client accounts. Churning is the excessive buying and selling of marketable securities, thereby increasing transaction costs for clients which are a revenue for the institution.
Bonuses are often paid for such things as: bringing in new money from clients; selling higher margin products such as mortgages; having clients shift their assets into in-house financial products; turning passive portfolios into ones actively managed by the financial institution.
What to Do
Never forget that a financial product is just like any other product.
The person or institution selling you the product wants to make money on the transaction. It is up to you to ensure you are not taken advantage of.
Know exactly what you are directly or indirectly paying for and if any other parties are compensating the advisor for product sales. If in doubt, request and obtain the information from the advisor or institution before buying.
If you have concerns about advisors, consider utilizing on-line discount brokers where you tend not to get offered new products.
You can also use fee-only advisors for advice.
I want to write a little on the differences between commission and fee-based financial advisors, but will save that for later in the week.
Never Forget the Relationship Between Risk and Return
On the whole, investment markets are relatively efficient.
If you are being promised an excessive return, always be wary. The product will have a higher level of risk than you anticipated. Or the expected return may not come to fruition.
This is not just a concern for small investors or those dealing with shady advisors. You can read about high net worth clients and sophisticated investors losing significant amounts of money because they invested in products or services with promises of excess returns.
What to Do
If the return looks too good to be true, it probably is.
If the return looks too good for its anticipated level of risk, it might be.
Always make sure you do extensive analysis on any such investment.
Never rely on the fact that wealthy or sophisticated investors have bought into the deal. Otherwise, you may be joining these same investors in a class action suit to recover lost capital. See the recent suit by Bernie Madoff’s clients as a good example.