Beware hidden biases

Written by Gary Silverman, CFP®

For years, the media hype has mostly been about how fee-only advisers (like me) are wonderful and unbiased. And for years, although I have enjoyed the attention, I’ve also warned you, my readers, that fee-only folks have their own biases. Rather than focus only on how your advisers charge for their services, you need to determine: 1) if they have your best interests in mind, 2) if they know what the heck they are doing, and 3) what their biases are.

Knowing those biases will pinpoint what actions are good for them and not so good for you. For example, fee-only advisers like to get assets under management. So if I recommend that someone not pay off a house mortgage, it may be the right call. But at the same time, it also means that the client will have more money to invest with me and in turn I’ll earn more money. So was I watching out for my client or for me? My commissioned-adviser friends earn money from the stuff their clients buy. So when their clients are told of a new investment that is good for them, the question again is whether bias plays a role. Are there other investments that are just as good but with lower expenses?

But there is a bit of a new wrinkle. There are a number of financial advisors, mostly doing work through Schwab or Fidelity, who are getting a kickback from those organizations if they use certain mutual funds in their clients’ accounts. And, you guessed it, these funds tend to be a little bit more expensive to own.

We are talking about advisers who sometimes act all holier-than-thou for using a discount broker and not using commissioned mutual funds for their clients. What most of their clients don’t know is that their adviser could be getting up to 0.2% of the value of a mutual fund investment kicked back to them each year. It may not sound like much, but that’s $1000 per year on a $500,000 portfolio.

Before I poo-poo on them too much, I am sure (or at least I hope) that this potential bias is revealed in the advisers’ disclosure document (it’s called Form ADV Part II) that is given to every client. However, just like mutual fund prospectuses, I do know that most clients don’t read the things. Thus their adviser might be: 1) making more money off of them than they realize, and 2) using investments that are more costly than they need to be.

The big part of that previous sentence is the word “might”. But if you don’t know it’s happening, it is hard to know the potential for bias. How can you know? Well, you might want to read the disclosure document, but I think it would be easier to just ask. Bring in this article and ask them if it applies to your accounts. Hopefully if it does they already told you. But if not, you now know another little area to monitor going forward.

This article was published in the Wichita Falls Times Record News on September 27, 2015.