Why revenue source matters

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Nick Foy, CFP®

An unfortunate reality of my industry is that you can make money as a “financial advisor” no matter who pays you. After the recent failure of the effort to require advisors act in their clients’ best interest, I’ve determined it’s time to call a spade a spade, and shed some light on those who masquerade as advisors.

The determining factor for each of these is the source of the revenue. Is the professional being paid to offer financial advice, to manage a portfolio, or to sell a product? If the latter, it’s likely they’re not actually a financial advisor. Here are a few of my favorites:

Life Insurance Salesman

If your financial advisor generates most of their revenue through the selling of life insurance, they are probably not a financial advisor. Everyone has a friend who is a life insurance salesman who has attempted to convince them that they need a certain type of life insurance. He might even be a really nice guy. But all too often, they’re successful in the endeavor.

There’s nothing wrong with selling life insurance. Lots of people need it. But, life insurance is just a part of the puzzle.

As Maslow said when describing his law of the instrument: “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”

Life insurance salesmen are in business to sell life insurance. It just so happens that their commision is much higher when they sell permanent life insurance. Coincidentally, very few people actually need permanent life insurance. A low-cost term policy to cover those who are at risk if you were to die prematurely is a great idea, but rarely will the life insurance salesman actually recommend this.

Instead, you’re likely to see charts and graphs showing the expected rate of return and portfolio growth over many decades with their permanent life insurance product. What they don’t show is the alternative options, the opportunity cost that is so important to understand the decision you’re making.

The White Coat Investor has done a great job detailing the pitch, which is given to just about every doctor, as well as most of the rest of us.

Annuity Salesman

Another financial professional who tries his best to look like an advisor is the annuity salesman. When I was in high school, I was victimized by one of these, so I know his type well.

I’ve been in finance for over 11 years now. I’ve worked hundreds of people. I’ve yet to meet one person who is a good fit for an annuity. I’m sure they exist, I’m just not yet sure what the profile of that person is.

An annuity salesman who has worked with an equivalent number of people probably hasn’t met one who isn’t a good fit for an annuity.

So, how do they get paid?

“…annuity commissions can range from 1% to over 10%, depending on the product. The commission correlation is easy to remember. The longer the surrender charge period, the higher the commission. The more complex the annuity is, the higher the commission. The simpler the annuity structure is, the lower the commission is to the agent. The shorter the surrender charge period, the lower the commission.”

So, the worse the product is for the client, the more they get paid. Got it.

If you’ve got an annuity salesman knocking on your door, do yourself a favor and at least compare it to annuities available from Vanguard and Fidelity. They won’t charge a commission and the operating fees are much more reasonable.

Better yet, talk with an actual fiduciary advisor who can help you determine whether or not an annuity is actually appropriate for you.

Mutual Fund Salesman

The mutual fund salesman might also sell you some permanent insurance with a dash of an annuity on the side. He makes a nice commission off of those two types of products. Why not make it a one stop shop and fling some mutual funds as well?

The typical mutual fund salesman will generate his revenue through the sale of funds which have a sales charge, typically called a “load.” The charge can occur at the time of purchase (a front-end load) or sale (a back-end load), and typically is over 5% of the transaction amount.

The mutual fund salesman probably won’t sell you funds that have low operating expenses, despite the fact that “expense ratios are strong predictors of performance. In every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile.”

Mutual fund salesman don’t know, or don’t care that the less it costs to invest, the more the client can expect to receive in return. Instead, generating a sales charge is of paramount importance to them.

There is a better way

Instead of working with a salesman, why not work with someone who is only paid by their clients? Reducing (or eliminating!) conflicts of interests is not only possible, there are advisors all over the place who are operating in a fiduciary capacity. Some even offer a monthly subscription model to their clients, making it possible for people with smaller accounts to get solid financial advice.

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