On his White Coat Investor podcast in June 2018, Dr. Jim Dahle interviewed Sarah Catherine Gutierrez, a financial advisor at Aptus Financial, which is based out of Little Rock, Arkansas. Ms. Gutierrez’s firm is relatively unique in the financial advisor world because she charges clients by the hour, rather than taking a percentage of assets under management.
During the interview, WCI and Ms. Gutierrez had an interesting discussion on the conflicts of interest that financial advisors have with different fee models, which I’ll summarize below.
Every fee structure has some conflicts of interest
Many physicians hire a financial advisor to manage their money. There are many different models of financial advising, and the fee structures used by financial advisors are evolving. There is no perfect fee structure for financial advising: all models have some conflicts of interest.
The only financial advisor who has no conflicts of interest is you. However, you can make errors (behavioral or knowledge-based), so there are many cases where a financial advisor can provide enough value to justify their cost.
Commission-based sales
This model clearly has the most conflicts of interest. A financial advisor in this model gets paid by the creators of the investment or insurance products they sell to you. They currently are not required to act as a fiduciary, so it’s possible for them to sell products that could actually hurt their clients.
Fee-only: Assets under management
There has been a strong trend in recent years towards a fee-only model of financial advising. Investors do not want their financial advisors to be directly paid to sell financial products.
The most common model of fee-only financial advising is to charge a percentage (most commonly 1%) of assets under management. Financial advisors who use this model are very motivated to increase assets under management. If you only have $100,000 under management, the financial advisor will be paid $1,000 per year for your services. But if you have $10,000,000 under management, the advisor will be paid $100,000 per year. The advisor is unlikely to spend 100x more time or effort on the $10,000,000 client than on the $100,000 client.
Therefore, financial advisors are very motivated to aggressively acquire new investors and increase assets under management. Financial advisors are incentivized to spend more time pitching prospective clients than taking care of the investors they already have.
In addition, there are situations where advisors can increase assets under management without helping their clients. For example, in some arrangements, 401(k) assets are not included as assets under management, but IRA assets are. Therefore, financial advisors may encourage investors to rollover 401(k)s into IRAs in order to increase their fees.
In another example, a financial advisor may discourage investors from paying off debt, such as student loans or a mortgage, and invest the money instead. This increases the amount of money that remains under the advisor’s control.
In an assets under management model, financial advisors are motivated to maximize investment returns, irrespective of risk. For example, they might encourage investors to hold a high-stock / low-bond portfolio, even if the investor may not have the tolerance to handle that type of risk.
Fee-only: flat rate or retainer
An alternative fee-only method is to charge a flat rate for advisory services, irrespective of the size of the client’s portfolio. This means that the total fees charged each year will be the same regardless of the amount of assets under management.
The main conflicts of interest with this model are that financial advisors are not incentivized to grow your portfolio. As Sarah Catherine Gutierrez mentioned in the WCI interview, there is a lower incentive to provide value when you are getting paid a fixed amount. You are incentivized to spend as little time as possible on current clients, and focus your time on acquiring new clients.
Fee-only: hourly rate
An emerging financial advisory model is to charge investors on a per-hour basis. This is like how a lawyer or an accountant might charge for their services.
As Ms. Gutierrez admits in her interview with WCI, the financial conflict of interest of this model is that they may work less efficiently to increase their number of “billable” hours. They also might offer to help you with financial advisory tasks that you might not need help with.
Everyone has financial conflicts of interest, including doctors
Anyone who has a job and makes money has potential financial conflicts of interest. Physicians are no different.
Of course, physicians can have conflicts of interest when they accept money or gifts from pharmaceutical companies or have an ownership stake in a medical device company. Besides these obvious conflicts of interest, there are other, more subtle, financial conflicts of interest in medicine.
For example, doctors are, in general, always incentivized to do more procedures. A surgeon is paid to do surgery, so there is always a conflict of interest that encourages them to recommend surgery versus a more conservative medical approach to treatment.
Even if you’re in a non-procedural specialty, you are still incentivized to do more. If you prescribe a new blood pressure medication to an otherwise healthy patient with borderline hypertension, then they will need to come back for multiple office visits for blood pressure rechecks and medication adjustments, increasing your billing.
Since doctors potentially control their own demand for their services, there are large financial conflicts of interest in a fee-for-service model. Some healthcare policy experts recommend switching to bundled-care models, which would pay a fixed amount of money for an episode of care. Of course, this would swing the pendulum in the other direction, and financially incentivize physicians to do as little as possible.
Conflicts of Interest Are Just Conflicts
Just because there exist conflicts of interest doesn’t mean that people, whether they are physicians or financial advisors, utilize that conflict of interest against their clients. Ultimately, it is up to the personal integrity of a person to do the right thing in spite of any conflicts of interest. We generally believe that physicians have a high moral standard and will not allow conflicts of interest to influence our treatment decisions. We believe that we also do what’s best for the patient.
Financial advisors may have conflicts of interest regardless of their fee structures, but that doesn’t mean they can’t provide the best service and do what’s right for their clients. When I purchased term-life and disability insurance, I worked with an insurance agent who is paid for each policy he sells. The agent is directly incentivized to sell me insurance, and he has the opportunity to sell me more insurance than I need or a more profitable form of insurance (e.g. whole life) that would net him a bigger profit. However, many insurance agents choose to only offer the correct type and amount of insurance for their client’s needs.
Conclusion
While you should always be vigilant in any financial transaction, whether you are working with home contractors, healthcare providers, or financial advisors, you shouldn’t cast a broad brush on any profession. There are good (and bad) people in every occupation.
However, choosing a fee structure with fewer conflicts of interest makes it more likely that you will be getting good advice. In my opinion, hourly rate fee structures are most likely to align the advisor’s interests with their client’s interests. Flat fee models are second best, followed by asset under management models. Commission-based sales have the most conflicts of interest.
What do you think? Is there any profession without financial conflicts of interest? What fee structure for financial advising has the least conflicts of interest?
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“However, choosing a fee structure with fewer conflicts of interest makes it more likely that you will be getting good advice. In my opinion, hourly rate fee structures are most likely to align the advisor’s interests with their client’s interests.”
The above quote is the take home. Yes, everyone has conflicts of interest… but the stronger the conflict the more tempting it is to view things as a 50/50 choice whereas one might be clearly right (not rolling over into an IRA when you plan on filling up a backdoor Roth versus keeping it in a 401K or opening a solo401K).
Minimizing conflicts of interest is really important. The other thing that I love about how Aptus Financial (Sarah Catherine Gutierrez’s firm) does things is that their plan is to make you as much of a DIY investor as possible. They want you to come in when you need some help or just want to do a tune-up, but otherwise encourage docs and other high income earners to be self-sufficient when possible. This style of financial advising is harder work for less pay, but it is the right way to do it.
TPP
Great summary! I had thoroughly enjoyed this podcast when I first listened to it; Aptus Financial’s approach is the one that made the most sense to me. I understand that many people don’t want to bother with money and simply want professionals to handle it, but if you don’t have much to begin with and don’t realize the true cost of using bad advice, then you can find yourself in a lot of financial trouble.
There appears to be a shift in the financial advisory world away from just managing investments. There’s a huge swath of the population that just needs good old basic financial advice that doesn’t rely on selling products or managing investments, so hopefully these needs will be better met in the future.
Nice commentary. I liked that you mentioned health care providers in the mix of conflict of interest. . As an OBGYN we do surgery. One of the things that disappeared me was when a new partner would hit the scene with the “have knife, will cut “ attitude. I would follow patients for years with rather mild changes in anatomy that in my opinion did not need to be operated. They had no complaints. You can guess what happened. Somehow the patient would be seen by new partner and operated. At the end of the year, or whenever numbers would be reviewed new doctor would have larger surgical numbers. The administration would praise new doctor for doing such a good job. Somehow new doctor left us. I wont say I discouraged his departure. I had the privilege of cleaning up new doctor,s complications of the patients who did not in my opinion need surgery in the first place. So I have seen conflict of interest in medicine. I happen to believe it is rampant and encouraged by the big medical organizations thinking of the bottom line first.
Thank you for the info. As head and neck surgeon in Kaiser, I have zero incentive to operate other than:
#1 it’s the right thing to do, and #2 I love doing the right thing for my patients. I’ve worked in other models, and the incentive to earn more off patients regardless of #1 and #2 above is OUT OF CONTROL.
In my early investing career during residency I fell for the commission based front loaded mutual fund suggested by my “financial advisor.”. Definitely felt taken advantage of looking back. Now I am more of a DIY guy
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