Sensible Perspectives

Wall Street Journal Article Highlights Sensible Financial Transparency

Posted by on April 17, 2017

KahnemanIn researching his recent Intelligent Investor column in the Wall Street Journal, Jason Zweig found that many financial advisors claim to be “conflict free”, either because they have fiduciary status or because they operate on a fee-only basis. Zweig argues that no matter how sincerely some advisors may believe it, they can’t be conflict free. The simple fact that clients pay advisors for their services creates potential conflicts of interest.

In contrast, Zweig identifies Sensible Financial for our forthrightness on the issue, citing the statement on our website: “No compensation structure can be conflict free.” He also quoted Rick Miller in the article: “We talk about that with our clients. Being straightforward with people about what the conflicts are makes for a better relationship.”

Why are conflicts inevitable?

People must pay their financial advisors somehow. Any payment structure that advisors establish will imply behavioral incentives and some of those incentives will conflict with the client’s interest. No one starts out to deliberately set up an incentive structure to create conflicts of interest with their clients, but conflicts are inevitable.

Any of us can be unaware of how incentives drive our behavior.  We have a psychological blind spot. Advisors want to believe they are always acting in their clients’ best interests, but everyone finds it hard to fully understand their own motivations.

For example, the origin of fee-only advice is rooted in countering a stock broker’s conflicts of interest with clients. Some practices, such as “churning” (where a broker buys and sells stocks solely to generate a fee), are obviously harmful to clients. Brokers also frequently receive commissions when they sell mutual funds, which implies a direct conflict of interest with their clients. The originators of fee-only advice saw payment based on assets under management as eliminating the broker’s conflicts.

But there are conflicts of interest in the assets under management model too, although they are not so obvious or easy to quantify. For example, a client buying an income annuity reduces the assets the financial advisor has under management, which means lower fees for the advisor. In this instance, while the annuity purchase might be the best thing for the client, it is not in the advisor’s interest.

Incentive systems compete for marketplace acceptance. The commission-based system is currently losing ground to the assets under management system because clients seem to prefer the latter. They think the latter makes it easier to see and manage potential conflicts of interest. However, even the assets under management system has conflicts.

The only sure way to avoid all conflicts of interest with your advisor is to advise yourself. But this is not a perfect solution either:

But my advisor is a fiduciary. Doesn’t fiduciary mean conflict free?

The CFP Board website defines the fiduciary standard of care to require “that a financial adviser act solely in the client’s best interest when offering personalized financial advice … investment advisers are regulated by the Securities and Exchange Commission (SEC) or appropriate state authorities and are required to provide services to their customers under the fiduciary standard.”

Thus, abiding by the fiduciary standard is a regulatory requirement. Investment advisers strive to meet it. We would argue that striving and transparency are essential to counter the inherent conflicts of interest we’ve been discussing.

How can you determine if a conflict of interest exists?

Each time your financial advisor makes a recommendation, ask “Does this recommendation benefit you (the advisor) in any way?”

Does Sensible Financial promise to eliminate conflicts of interest?

As illustrated by the statement on our website, we strive to point out situations where conflict is most likely to occur, to be transparent. We know that we can’t eliminate conflicts.

We believe that if you identify the imperfections in a system, you can get better results.

As Zweig concludes in his article, “(Sensible’s) admission can be the start of a fruitful conversation about whose interests come first. That’s a much better basis for trust than any pretense of perfection.”

We know we’re human, and we’re always open to discussing both the analytical underpinnings supporting our advice and potential conflicts. We want you to be confident about the advice we give and the decisions you make.