First place is a Cadillac, second place is a set of steak knives and third place is “you’re fired.”
Anyone who has seen the movie Glengarry Glen Ross will remember Alec Baldwin’s unconventional pep talk announcing a sales contest for a small-time real estate sales firm.
The sales culture of financial advisory firms isn’t quite so dramatic, but many people are still surprised to learn that the firms that employ their or their family’s adviser may have quotas, contests, and bonuses based on how much their advisers sell – not on how well they deliver good advice.
Quotas vary dramatically from firm to firm. Some full service brokerages expect each adviser to bring in $5-million to $10-million in new assets per year. Others require an adviser to bring in at least a few hundred thousand dollars in commissions every year. If advisers fail to make that quota, their payout – the percentage of the commissions they get to keep – can be cut in half. The cut, of course, is designed to encourage low performers to quit before they get fired.
From an investor’s perspective, these targets have one thing in common: None of them are aligned with the goals of putting you in the best possible investments or giving you a great financial plan.
Most of an adviser’s compensation is tied to commissions or trailer fees on mutual funds and other products, so an adviser has no direct incentive to deliver financial planning, which would include identifying insurance coverage you may be lacking, quarterbacking the creation of a plan for your estate, ensuring little Johnny has school paid for by the time he’s 18, or preventing your retirement diet from including dog food.
Quotas mean conflicts of interest. For example, a typical equity mutual fund might produce a 1 per cent annual commission to the firm, but a typical fixed income mutual fund might generate only a 0.5 per cent commission. An adviser struggling to meet a commission quota would need $2 in safer funds to generate the same revenue as $1 in a riskier fund.
This puts an adviser in the difficult position of choosing between what is in his interest and what is in his client’s interest. The risk profile of a portfolio should be determined by the needs of the investor, but the egregious imbalance of compensation skews some advisers toward building risker portfolios than are warranted. There is almost no incentive for an adviser to suggest that a client hold a portion of his or her portfolio in cash since that generates no commission.
To their credit, some financial advisers ignore the complicated formulas used to determine their take-home pay and focus simply on their clients’ needs. As long as they are not bottom-rung performers, this works out well for everyone.
But not all advisers are so focused on the client. You should be aware that the person sitting across the desk from you may be driven more by incentives and quotas than what your portfolio actually needs.
Is there a way to solve this problem? I hope that advisory firms come to recognize that providing comprehensive financial planning doesn’t have to be an overhead cost; it could actually be a competitive advantage that can increase revenue through referrals.
But for that to happen, consumers have to become more demanding. Too many people think a simple investment growth projection is a financial plan. It’s not. Unless your adviser has already given you a written statement that examines everything from your portfolio to your insurance needs to your retirement desires and estate planning, you should be looking around for one who can.
Preet Banerjee, a personal finance expert, is the host of Million Dollar Neighbourhood on The Oprah Winfrey Network. You can read his blog at WhereDoesAllMyMoneyGo.com and follow him on Twitter at @preetbanerjee.