Mrs. Baxter's 'Financial Advisor' - A Sad Tale of Deceit and Betrayal

ALL POSTS PRIOR TO 2021 HAVE NOT BEEN REVIEWED NOR APPROVED BY ANY FIRM OR INSTITUTION, AND REFLECT ONLY THE PERSONAL VIEWS OF THE AUTHOR.

March 3, 2017:

Against the backdrop of the Trump Administration's initiative to delay, and then repeal, the DOL fiduciary rule (designed to eliminate, or at least minimize, conflicts of interest between financial advisors and their clients), we often forget the real harm caused to our fellow Americans under the current regulatory regime. Each and every day individual investors are scammed. They believe they receive trusted advice from expert professionals, when in most cases that is just not so.

The sad reality is that the person sitting across the table from the individual investor is more likely than not just pushing products - expensive mutual funds destined to underperform, even more expensive hedge funds and floating rate securities, fixed (equity) indexed annuities with often-excessive commissions issued by insurance companies with inadequate financial stability, high-cost variable annuities with illusory "guarantees," and much more.

Most individual investors think they are doing fine with their current "advisor" - when in reality they are subjected to what I call "financial rape." It's a continuous battle to open up the eyes of individual Americans, and then to guide them on how to choose a trusted, bona fide fiduciary.

In this post, I relate the story of "Mrs. Baxter." Not her real name, of course, nor even representative of a single client. But, this tale is, rather, a compilation of hundreds of individual investors I have counseled over the years. Indeed, there are millions of "Mr. Baxters" and "Mrs. Baxters" out there  who are unaware of the harm which is imposed upon them. And, as seen in this post, they need help - from true professionals who operate at all times as "bona fide fiduciaries."

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"Mrs. Baxter, the total fees and costs charged in connection with your investment portfolio are well over 2% a year, and approach 3% a year," I opined.

The 63-year old Mrs. Baxter, a recent widow, seemed un-phased. "They must be great investments, then," she replied.

"No, ma'am," I replied, "the extra fees and costs you are being charged are reducing the returns of your portfolio, over time. In fact, even though you are withdrawing only three and a half percent of your portfolio, each year, with the excessive fees and costs you are paying your portfolio is unlikely to grow further. And, most importantly, you'll likely run out of money during your lifetime."

Mrs. Baxter sat up in her chair. "But my financial advisor said I would be fine."

"Do you know how much his firm is paid, from your investment portfolio," I inquired.

Mrs. Baxter appeared puzzled. "I'm not paying my financial advisor anything. He's never charged me a dime."

"Sadly, ma'am, that's not the case. Between the sales loads, or commissions, you've incurred, as well as the 12b-1 fees charged by many of the mutual funds you own and paid to your brokerage firm, the  extra payments made by your mutual funds and variable annuities to your brokerage firm called "payment for shelf space" and "marketing support dollars," soft dollars, and more, your brokerage firm is receiving about 2% a year in fees."

Mrs. Baxter replied, "That can't be."

I took several minutes to review the printout of my spreadsheet with her. Like about one-third of individual investors, Mrs. Baxter thought her broker didn't charge any fees at all. And, like about 80% to 90% of individual investors, Mrs. Baxter had no clue about her total fees and costs.

It was surprising that Mrs. Baxter was in my office now. If her daughter had not insisted that she get a second opinion on her portfolio, she likely would have never learned what she is learning now.

I continued. "Mrs. Baxter, on your $1,000,000 portfolio, the total fees and costs you are paying are about $26,000 a year. You are paying more than twice in fees and costs that you should. And, your investment portfolio is also not designed or managed in a way to minimize the tax drag on your investment returns. In essence, you are paying several thousand dollars a year, each year, in taxes you should not have to pay."

"In sum," I continued, given the seven years you've been with your financial advisor, the value of your portfolio is far less than it should be. It should be worth at least 10% more, and quite probably an even higher amount. The academic evidence is compelling: high fees and costs, and excessive taxes, drag down your investment returns substantially, and the effects of compounding increases the severity of the harm to you over time."

I had yet to deliver all of the bad news. "Mrs. Baxter, also, your portfolio is exposed to too much risk. There are ways to design portfolios that minimize different types of risk. But this portfolio does none of that. To put it bluntly, this portfolio is not designed by an expert, and it puts your financial future in serious jeopardy."

Mrs. Baxter, her eyes now wide open, had a good question for me: "The sign in my financial advisor's conference room said, 'The Best Interests of Our Customers Should Come First.' Did my financial advisor break his vow to me - to act in my best interests?"

"Unfortunately, Mrs. Baxter, that sign did not clearly state that your financial advisor, and his firm, are required to act in your best interests. It is marketing hype, and it is, unfortunately, quite deceiving. The firm is not a fiduciary to you. Your financial advisor is a product salesperson, not a trusted advisor."

Mrs. Baxter appear confused, as I continued. "I've checked on your 'financial advisor.' He's just a stockbroker, who has been in the business for several years. He also sells expensive insurance and annuities. Yet there is no evidence that he possesses any substantial training in planning to address retirement needs, in taxation, or in portfolio theory and management. While he has a few designations after his name, most are meaningless. In fact, there is no evidence that he possesses the substantial knowledge and expertise that a true professional should possess to advise you on your investment portfolio and retirement planning."

"But he calls himself a 'financial advisor'!" Mrs. Baxter said now. It was clear that she was getting emotional. Her anger was apparent. And her expression changed from time to time to one of concern - as she should be concerned about the real threat to her own financial future. She asked, "Can I sue him?"

"Sadly, I don't see how a lawsuit would be successful," I replied. "All of your account documents stated that the advisor was not a fiduciary to you. Your broker appeared to recommend 'suitable' investments, but he had no duty to recommend the best investments to you. In fact, many of the recommendations made appear to have been done because they paid your broker, or his firm, more money."

Mrs. Baxter just sat there. Stunned. I knew she never read the mountains of disclosure documents she was presented. Even if she did read them, like so many Americans she does not possess the high degree of financial knowledge necessary to discern what was important, and what was not.

"Mrs. Baxter, here's what I want you to do. Take my written analysis home. Look over it. If you desire, seek out another second opinion."

Mrs. Baxter said, "I've already decided. I'm going to make a change. I want you to take over my portfolio."

I knew it was not time for her to make any important decisions, especially regarding her own future retirement security. Certainly no one should make decisions about money in such an emotional state. So I replied, "Mrs. Baxter, let's meet again in a week. And we will go over the analysis, make certain you understand it, go over my own portfolio recommendations for you. Write down your questions over the course of the net week, and I'll answer all them when we meet."

"But I don't have any questions."

"Mrs. Baxter, I can assure you that a week from now you will have questions. Good ones, too. But for right now, and for several days, it is in your best interests to let what I've told you sink in. You should review this analysis. Then we'll review it again, together. And then, and only then, will we proceed together to fix your portfolio and make it work a lot better for you - with far less fees and costs, substantially reduced taxes imposed on you, and with far less risk that you will outlive your money."

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If you are an individual investor, and you've read this, what can you do?

• First, ask your current "financial advisor" (or whatever title he or she uses) these questions. Get the answers to these questions, in writing. Be aware that many investment or financial advisors say that they are "fiduciaries" or that they act "in your best interests," when in fact they do not. This questionnaire should result in "yes" answers to each and every question; otherwise, your advisor may not be a bona fide fiduciary (in the author's view).

• Second, get a second opinion about the management of your investment portfolio. Ask the same questions, first, of those you approach for a second opinion. And get the answers in writing. If all of the answers are not "yes" - keep looking. Find a true expert, trusted advisor. Find what I call a "bona fide fiduciary." They are out there, and when you find them your own financial future will become much more secure as a result. 

• Third, and in addition to the answers to the questions referred to above, have your advisor provide you with a certification of his or her (or the firm's) allegiance to bona fide fiduciary practices. The three documents currently available that meet this requirement are:

1. The Fiduciary Oath from The Committee for the Fiduciary Standard (any advisor can sign this oath; no cost involved, nor membership required);
2. The Fiduciary Oath from the National Association of Personal Financial Advisors (NAPFA) (members of NAPFA, who are fee-only and who meet certain educational and testing and review requirements, sign this oath); or
3. The Best Practices Fiduciary Advisor Affirmation from the Institute for the Fiduciary Standard (the Advisor Affirmation Program requires firms to pay an annual fee, have their Form ADV reviewed, and require language inserted into their Form ADV).

Realize that your financial goals, hopes and dreams are too important to risk to chance. Seek out the best. There are bona fide fiduciaries out there - expert, trusted professionals. But they remain outnumbered by non-professionals in this business by about 10-to-1. So be prepared to search diligently, and don't ever accept anything less than a true, bona fide fiduciary.

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If you are an existing financial advisor who is not currently acting as a trusted professional, you are likely tired of pushing proprietary products, or products that pay your firm "payment for shelf space" or other forms of revenue sharing. You likely want to act in your client's best interests, at all times and without exception; but your firm just is not structured to permit you to do this. You want to deserve the trust that your clients place in you. What should you do?

• First, realize that for several decades now a growing body of independent, fee-only advisors has existed. These fee-only advisors avoid nearly all conflicts of interest. They don't accept material third-party compensation (commissions, 12b-1 fees, payment for shelf space, revenue sharing, sponsorship of client seminars, prizes, awards, etc.). And - they make an excellent living. More importantly, they love what they do - they look forward to going to work each and every morning, for they know that each and every day they transform the lives of their clients for the better.

• Second, attend a conference of fee-only financial advisors. There are many worthwhile fee-only organizations out there, but the largest and most established is the National Association of Personal Financial Advisors (NAPFA). At their Fall or Spring conference you'll find sessions on practice management, portfolio design and management, how to identify and use the best technology, and much more. More importantly, you will meet other advisors who previously fled the world of product sales for the world of trusted advisors. They and everyone else at the conference will greet you warmly. You'll receive advice from everyone who has gone before you, and you'll be invited to join this collegial community of professionals. You'll go away from the conference knowing that a pathway to excellence exists, and you will more firmly visualize the route you must take toward a more personally rewarding career.

• Third, if you are considering joining another firm, there are many opportunities out there. If you possess established client relationships (please, don't call it a "book" any more!), there may be firms - both large and small - that you can join. These firms already operate as bona fide fiduciaries. Many of these firms have assisted "breakaways" before. So, explore your options, quietly and discretely. You'll be glad you did!

• Fourth, if you are already with a broker-dealer firm and/or insurance company, then before you begin the actual planning for any transition to "go independent"- get legal advice. You have rights, and so do your clients. To avoid missteps, and to better the odds that your clients will follow you, seek out legal advice from securities law and/or compliance attorneys who have previously advised on many advisor transitions. Don't skimp on good legal advice as you plan to make the transition. 

• Fifth, realize that once you make the decision to transition to an independent firm (existing, or your own firm), and to practice as a bona fide fiduciary, you'll never want to go back! In fact, very, very few of those who leave the "sell side" of this industry for the "buy side" ("purchaser's representative" or "fiduciary") ever return. (In fact, in all my years, I've never, ever, met even one who left the sell-side and then returned to it later!) So, be confident that you've made the right decision!

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If you are an existing financial professional who already operates as a bona fide fiduciary, congratulations! Like me, you likely love your profession, and your career path.

And, you are likely upset about the developments in Washington, D.C. While you see that the Trump Administration's decision to kill off the DOL fiduciary rule favors your own practice (as you will retain a marketing advantage as a true fiduciary), you also recognize the harm that is done to your fellow Americans, each and every day. You know that fiduciaries will prevail in the marketplace over time, but you are saddened that it will take longer for financial planning and investment advice to shed the "product sales culture."

• First, don't give up. Although there is only a small chance to get the Trump Administration to reverse its course, this is a fight that continues to be worth fighting! Submit a comment letter on the DOL's proposals to delay the fiduciary rule. (Do so today!) Ask your colleagues to submit comment letters. And ask your clients, as well. Share, to the extent you can, stories of the "Mrs. Baxters" of this world - with the DOL, with your U.S. Senators and members of the U.S. Congress, and with your local media.

• Second, realize that even if the DOL fiduciary rule is delayed and then either rescinded or replaced (with a weak rule), much progress has been made in recent years. Several courts have already upheld the DOL fiduciary rule on its merits. Hence, all it takes is a future change of the Administration, and before long a new version of the DOL fiduciary rule - likely even improved and stronger - will emerge again and be adopted and finalized. It's inevitable. So, have hope that a better day will come - for all Americans, not just the ones lucky enough to have you as their investment and financial advisor.

Ron A. Rhoades, JD, CFP(r) is the Director of the Financial Planning Program at Western Kentucky University's Gordon Ford College of Business, Bowling Green, Kentucky. Dr. Rhoades teaches courses in investments, retirement planning, estate planning, and managerial finance.

Ron is an avid researcher into fiduciary law as applied to financial services, and has written and spoken extensively about the fiduciary duties of financial advisors, the status of laws and regulations, investment due diligence, and the paths toward a true profession.

This post reflects his views only, and are not those of any institution, organization or group with whom he may be associated. To reach Ron, please e-mail: ron.rhoades@wku.edu. Thank you.