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J.R. Whalen: Before we get into today’s episode, Your Money Briefing is exploring what you need to know to become a homeowner and sustain your home. You can get early access to our series Buying a Home and Keeping It, on WSJ Special Access, available only for WSJ subscribers. Now onto the show.
Here’s Your Money Briefing for Monday, April 15th. I’m J.R. Whalen for the Wall Street Journal. A financial adviser can help you decode the markets and find smart ways to invest. But some advisers make recommendations that wind up not being in your best interest.
Anne Tergesen: If I’m your adviser and I’m charging you 1% of your portfolio, I get paid more when your portfolio does well and goes up. So if I’m making good investment decisions, then that’s going to benefit both you and me in tandem. With the commissions, the incentive is to sell you products, whether you actually need them, whether they’re actually in your best interest or not.
J.R. Whalen: We’ll talk to Wall Street Journal personal finance reporter Anne Tergesen after the break.
Your fee-based financial adviser’s recommendations for boosting your portfolio may create conflicts that aren’t in your best interest. Wall Street Journal personal finance reporter Anne Tergesen joins me. Anne, what’s the difference between fees an adviser might charge and commissions?
Anne Tergesen: It’s become increasingly popular for advisers to charge fees rather than commissions. Now, with the commission, the way it would traditionally work is that a broker would charge you commissions. They would say, “Hey, I’ve got a stock tip for you,” or “I’ve got this great annuity I want to sell you.” And they would sell you investments that they would charge a commission on for you to purchase. So that would be a sales-oriented relationship. They would have an interest in selling you products that would earn them money through commissions. But with trends in the marketplace, a lot more advisers have given up commissions, and instead, they charge fees. And typically, what that involves is they charge, say, about 1% of your portfolio’s value annually in order to manage your portfolio and provide you with a financial plan and an ongoing relationship.
J.R. Whalen: So it’s not piecemeal charges like a commission would be. It’s one charge per year sometimes?
Anne Tergesen: It’s one unified charge, and they will justify that charge by saying they provide a number of services, including financial planning, which is important for people.
J.R. Whalen: Why do consumer advocates support the fee-based financial planning?
Anne Tergesen: There’s a feeling among both regulators and consumer advocates that the fee-based financial planning better aligns the economic interests, the financial interests of the adviser with the client. So, for example, if I’m your adviser and I’m charging you 1% of your portfolio, I get paid more when your portfolio does well and goes up. So if I’m making good investment decisions, then that’s going to benefit both you and me in tandem. With the commissions, the incentive is to sell you products, whether you actually need them, whether they’re actually in your best interest or not.
J.R. Whalen: In your reporting, you say that sometimes fee-based structure can lead to conflicts of interest among some advisers. What kind of conflict?
Anne Tergesen: There’s been a lot of attention paid to the conflicts of interest that brokers face, but there’s been less attention paid to the fact that fee-only advisers also face conflicts of interest. And their conflicts of interest really involve financial decisions that could potentially cause a client to reduce the size of their portfolio. For example, the big one is the decision about a mortgage. “Should I carry a mortgage or do I want to pay it off early?” And advisers, a lot of them do recommend paying them off early if that’s what the client seems to want to do, but there is a conflict of interest that they face where if you take a big chunk of money out of your portfolio to pay off a mortgage, then you are reducing the size of your portfolio substantially and you’re reducing the size of their paycheck.
J.R. Whalen: But eliminating debt is important to some retirees as they approach retirement or are in retirement.
Anne Tergesen: Yeah. I mean, in recent years, that mortgage decision has been a sort of a more nuanced one because a lot of retirees have very low interest rates on their mortgages. So there’s a feeling that “Well, if you leave the money in the stock market, you’re going to earn more than you would by basically paying off that mortgage.” So it is a complicated decision. A lot of advisers recommend leaving the money in the market because they feel the client can do better that way, but it’s also clear that the adviser can also do better that way.
J.R. Whalen: How about the decision as to when to take Social Security the first time? How does that factor into this?
Anne Tergesen: I was kind of interested in this in part because there’s a new study that looks at that very topic about claiming Social Security. So it looked at what type of adviser they have and when they claim Social Security. And what they found is that a decent number of people with advisers claimed at a relatively early age, which was not what the authors of the study had expected. And they expected that people who have advisers will be advised to claim later because that’s often optimal claiming strategy, especially for people who are wealthier, who tend to live longer, especially for married people. The higher earner claiming later is often better. The study found that, in fact, these people were claiming earlier. And the theory is that adviser bias and conflicts of interest could be playing into this, that the adviser doesn’t really want you to delay claiming because you’re going to have to support yourself solely from the nest egg, which means you’re going to take more money from your portfolio, which, again, causes the balance to go down, causes the adviser’s paycheck to go down.
J.R. Whalen: How can an individual investor seek out an adviser that doesn’t make recommendations that might carry conflicts?
Anne Tergesen: There is a breed of adviser that charges fees, but they charge hourly fees or project-based fees. So those people don’t have an incentive to maximize the size of your portfolio for better or worse. It’s nice to have your adviser have that incentive, but they also don’t have the incentive to make recommendations that are designed to keep money in the portfolio when there might be better uses for it. So-
J.R. Whalen: Well, they’re getting a stream of fees along the way.
Anne Tergesen: They are. But the downside to some of that is that, first of all, it’s harder to find an hourly-paid adviser. It’s not impossible. There’s networks of advisers like the XY Planning Network and the Garrett Planning Network that are significant numbers of hourly-paid professionals, but that’s not a model that is all that common. So it’s harder to find them. Sometimes they will do a financial plan for you, but they’re sort of better for people who are happy to implement that plan themselves. You can always pay them on an hourly basis to implement it, but the focus with those advisers often tends to be that they’re better for people who are comfortable managing their own portfolios, and a lot of people just aren’t. The takeaway from this is that people should feel comfortable with the idea of an adviser who charges, say, a 1% fee ongoing for managing their money, but they need to be aware of these potential conflicts. And when an adviser makes a recommendation, they need to probe carefully why the adviser is making that recommendation. They need to make sure that they’re really comfortable with it.
J.R. Whalen: That’s WSJ reporter Anne Tergesen. And that’s it for Your Money Briefing. We’ll be back tomorrow morning with WSJ’s Laura Saunders to discuss what to do if you sent in your tax return, but then realize you made a mistake. This episode was produced by Ariana Aspuru, with supervising producer Melony Roy. I’m J.R. Whalen for the Wall Street Journal. Thanks for listening.
