What Distinguishes Good Financial Advisors from the Poor Ones?

In a recent post, an anonymous commenter took me to task for my opinion that mutual funds should not be permitted to pay financial advisors. Rather than just rebut the commenter’s argument, I want to use it to illustrate an important difference between good and bad financial advisors.

Here is the criticism edited for length (the original comment is here):

You say “If advisors are performing a valuable service, their clients should be willing to pay them directly.” How do you reconcile this statement with you making money via advertising on your site? If you feel that should be the ONLY model, why not charge people directly for this site? When you go to a store and a salesperson helps you pick out a product, do you pay them separately or assume their compensation is included in the sticker price?

Of course, the reason I don’t try to collect a few pennies each time a reader visits my site is that the overhead would be far too high. It’s obvious which parts of my site are content and which are advertising. Readers can make an informed choice about what they read here.

The analogy between investing and buying a consumer item is far more interesting. It illustrates an important difference between good and bad advisors as I’ll explain.

To put dollar amounts on an equal footing, let’s compare buying a $25,000 car to investing $25,000 in mutual funds.

Consumer View

When I buy a $25,000 car, I think of it as spending $25,000. I know that my money gets split up in some way among the car salesman, the dealership, the manufacturer, and possibly other parties. Knowing the actual split might help me negotiate a lower price, but for the most part I don’t really care how the money gets divided.

When I invest $25,000 with an advisor I don’t think of it as spending at all. I am entrusting my money to an advisor, his firm, and the fund managers. I hope to get back this money and more in the future. I’m entitled to know what fees I pay for the services I get.

When buying a car, I know I’m spending $25,000. But when I invest, most of the money I hand over remains my money. The only amounts that I’m actually spending are the (usually hidden) fees. Over a lifetime these fees can be substantial and investors should be given a reasonable opportunity to understand how much they’re paying.

Advisor View

A good advisor thinks of client money similarly to the way clients think of it; the money is entrusted to the advisor. These advisors see good stewardship of client savings as an obligation.

A car salesperson sees the car purchase process as one of convincing a consumer to buy a car and collecting a cut of the price. The salesperson uses various techniques to close the sale and then moves on to the next potential purchaser. The salesperson has little reason to feel any further obligation to the purchaser, and purchasers generally understand this even if they find the process uncomfortable.

An advisor who sees a parallel between selling consumer items and selling mutual funds is very likely to be a bad advisor not worth a client’s trust. A client expects the advisor to provide ongoing good stewardship of the client’s savings. An advisor who feels no such obligation has deceived the client.

Conclusion

There are important differences between selling consumer items and selling mutual funds that cut to the core of why people go to financial advisors. I don’t believe that government should try to protect people from every possible small harm. However, the treatment people get from a great many financial advisors and the mutual funds they sell is a large harm. Costs over an investing lifetime can easily climb into the 6-figure range and people are generally oblivious to this high cost. I see no effective remedy other than to cut off payments from mutual funds to financial advisors.