It’s a sad fact, but brokers don’t always act in your best interest. And there is nothing that requires them to. It may be hard to believe but brokers, investment specialists, insurance agents, some financial advisors, and other professionals that you trust with your money aren’t always required to act in your best interests.
Suitable vs. fiduciary standard. Brokers are required to recommend “acceptable” or “suitable” investments, but “suitable” doesn’t mean the best performing stock or investment, just that it is an appropriate investment. As a result, some brokers recommend investments with higher commissions. Registered investment advisors, however, are required to follow a fiduciary standard, which means they must put your interests before their interests. An example would be choosing the fund with the lower expense ratio.
Should investment professionals be required by law to act in your best interests?
There are many people calling for change in the financial and insurance industries to require professionals to act in the best interests of their clients at all times. Unfortunately, there is no current requirement.
I have had two bad experiences with financial advisors – once with an independent broker and once with a broker who worked for a well-known investment firm. These two bad experiences changed the way I act toward investing by forcing me to earn more and become more hands on with my approach to investing.
My $1,000 investing mistake. My first bad experience involved meeting with an independent broker who was recommended by a coworker. At the time I didn’t know much about investing or even enough to do a background check on the broker. At the broker’s recommendation I bought into a front loaded mutual fund that essentially tracked the S&P 500, and not only charged a large front load fee ($1,000), but had an ongoing 1.5% expense ratio.
After a couple years I learned more about investing and realized the fund I had invested in was not the best investment for me. I moved the investment to Vanguard where I paid much lower expenses, but unfortunately, the load fees were gone forever. This was an expensive mistake, but in a way I’m glad it happened. I learned more about investing and it prevented me from making more expensive mistakes later on. You can read more about this mistake in this article about why you should research investments before buying.
The broker who interests trumped mine. The next situation came several years after the first, and I was wiser and more fiscally responsible. I had done some reading on investing and was ready to contribute beyond the $3,000 I was contributing to my Roth IRA each year (back when IRA contributions were capped at $3,000).
I set up an appointment with a financial advisor at a well-known firm. I was seeking advice about developing financial goals and how/where I should invest. After listening to my situation he handed me a one page fund sheet and told me that was the fund I needed to purchase. Before I had finished reviewing the sheet or asked any questions about it he essentially shuffled me to his secretary. But along the way he was nice enough to ask me to leave a canceled check so they could immediately begin an automatic investment plan. He also gave me a stack of business cards to hand out on base (they made it as far as the trash can outside his office door).
Needless to say, I didn’t hand over the blank check before leaving. I went home and researched the fund and discovered it had a very high expense ratio and probably a high commission as well. I don’t think all funds with high expense ratios are bad, but this fund was another mirror of a popular large cap index fund. In no way was it better than what I was already doing. This broker put his needs before mine by trying to sell me a high priced fund without taking the time to explain to me why this was the best option for my needs (he brushed off most of my questions during the short appointment).
The common denominator: In neither case were my interests as an investor placed first. Both of these examples served the financial advisor more than they served me. In the first example, I made an expensive mistake and the broker received a nice commission for his sale. But it also prevented me from making a similar mistake the next time I visited a financial advisor.
Reader question: Should all financial brokers, advisors, insurance agents and others be required by law to follow a fiduciary standard of care – that is to say, put the interests of their clients ahead of their own interests?