Having a large army of financial advisors is one of the most profitable lines of business for Wall Street firms. But is working with a Financial Advisor from a Bank or Brokerage the best choice for clients?
When the average person thinks about financial advisors, it’s difficult to distinguish them from stockbrokers – because their business model is the same. They sell stocks, mutual funds and other securities.
“Brokers” is a profession that inspires a wide-ranging set of emotional word associations: glamour, greed, opulence, corruption, contempt, desire.
It’s perfect stuff for Hollywood lore. And indeed, Hollywood has embraced the greed angle in classics from Oliver Stone’s “Wall Street (1987)” with Michael Douglas and Charlie and Martin Sheen, to “Boiler Room (2000) with Ben Affleck, Vin Diesel and Giovanni Ribisi”, to the classic “Glengarry Glen Ross” (1993) from David Mamet with Alec Baldwin, Al Pacino, Jack Lemmon, Ed Harris, Alan Arkin and Kevin Spacey.
These films have brought little mottoes into the American lexicon, mottoes like “ABC – Always Be Closing.”
These films mostly get the bottom line correct: The business of Wall Street is the business of SELLING securities to people, often insecure people.
Consider Ben Affleck in “Boiler Room”: “…There is no such thing as a no sale call. A sale is made on every call you make. Either you sell the client some stock or he sells you a reason he can’t. Either way a sale is made, the only question is who is gonna close? You or him?”
His character also says: “Anybody who tells you money is the root of all evil doesn’t f… have any.”
In “Glengarry Glen Ross,” the classic pressure case is summed up when Blake (Alec Baldwin) says to Jack Lemon’s character: “Put. That coffee. Down. [pause] Coffee’s for closers only.”
Now these films may not display the average conversation and pressure that Wirehouse salesmen are under, but the underlying currents are true throughout the business of financial sales. The business is selling securities: pure and simple.
Sometimes the securities that are sold are good, appropriate securities; sometimes they are not. In either case, the salespeople get paid. Don’t forget, by and large, that financial advisors are very rarely bad or even greedy people; they are simply people who are doing what their employers tell them.
The “average” Merrill Lynch Broker produces $853,000 of revenue (in the industry this is known as “production”) per annum for Merrill Lynch. That’s more than $3,500 of “production” each working day. Suffice it to say, they are under a lot of pressure to sell.
Professional Services involve Life-critical issues,
Professional service providers, by the nature of the high value of the service that they provide must not be beholden to the financial pressures of public ownership. By professional service providers, I am talking about doctors, lawyers and, yes, financial advisors.
A conflict of interest exists when the professional must choose between serving the client and serving the corporation and its shareholders. This conflict is manifest in our understanding of the highest calls to duty: In public service, the duty is to serve the people; in medicine, doctors follow the Hippocratic oath; in law and finance, it’s the fiduciary obligation, the legal obligation to act in the best interests of clients.
The advisor’s fiduciary obligation to his clients clashes with his obligation to the corporation. Professionals are serving clients on life-critical issues their money, their health, and their rights under the law. This is different from public companies who sell us products. We don’t mind Procter & Gamble maximizing its profits selling us toothpaste. But no one wants his or her doctor to be focus on their bottom lines.
In health, you want your doctor to do whatever is in your best interests. You do NOT want him to maximize his firm’s profits. Similarly, you do not want your lawyer to be focused on maximizing his profits for his firm. What you want is for him to save you money and to keep you out of jail.
The problem for professionals who are employed by public companies arises from the nature of the obligations of a public corporation. Public corporations are mandated to maximize shareholder value.
That means they have incentives to grow the business, ideally 10% every year, even if this means that clients get an increasingly profitable and efficient service that is focused less on the clients’ well-being than on getting more profit, either by adding more and more clients or on selling additional services or products.
Wirehouses are now mostly public owned
One of Wall Streets biggest problems, and it’s a problem for you, the client, if you happen to be a client of one of these firms, is that the largest wirehouse brokerages are publicly owned corporations (Merrill Lynch is now owned by Bank of America, Smith Barney, formerly owned by Citigroup, is now owned by Morgan Stanley, Ameriprise is owned by American Express.)
As a shareholder in public companies I fully understand the mandate under which public companies operate. However, I do not believe that professionals who provide a high-skill service, which engenders the well-being of clients, should be employed by publicly owned corporations.
The reason is simple: The interests of the shareholders and the interests of the client are not aligned.
Advisors who work for publicly traded companies, including most of the large wirehouse brokers, feel this obligation rubbing them against their clients’ interests and well being.
It’s quite a dilemma: Is their ultimate allegiance a fiduciary obligation to his client (in which case he should seek to minimize fees and commissions), or to the corporation (in which case he is aiming to maximize revenue per client)? At a minimum, the broker feels the imperative to sustain the high production quotas to which the shareholders of the publicly traded company are accustomed.
The bottom line: These brokers do not serve you best.
Wall Street’s Scale: Number of Clients served
In order to pay for those shiny NYC buildings and in the interest of profitability, Wall Street advisors bring scale to the business of financial advisors. A typical broker will service and sell to five, 10, or even 20 times the number of clients that an independent advisor would be willing to serve..
Excellent boutique money managers and registered investment advisors limit the number of client families that each investment professional is responsible for to 50 or fewer families per advisor. Wall Street brokers, on the other hand, maintain books of business with hundreds, sometimes even a thousand client families for a broker. There is an obvious qualitative difference in service and customization between the two.
So how does an average wirehouse broker serve most clients?
Most are adequately served with products that pay large commissions upon sale. Some clients don’t pay fees, but the brokers make 2+ pts (that’s industry parlance for 2%) when they sell a bond at 102 that they bought for 100.
Every year thousands of people switch advisors. They usually choose to work with the largest, most well-known brokerages, such as Paine Webber, Smith Barney, Merrill Lynch, Prudential, Axa, Ameriprise, and Chase.
This is a mistake because the largest brokerages are made up of ordinary advisors who are “working for the man.”
If you are seeking a new advisor, search for one who is beholden to no one but his clients and his own reputation.
Annuities Undressed:
Wall Street brokerages sell a lot of insurance and annuities. Insurance and annuities sales can often be among the worst deals for clients. A front-end loaded annuity pays a commission of anywhere from 3% to 7% for the broker.
When you buy $300,000 of an annuity, your “broker” just produced between $9,000 and $20,000 of revenue from you for his firm. It’s even worse than all that. Total fees can easily equal a third of the total return of the product over its lifetime. And if you want to change your mind and get rid of the annuity policy, you’re probably looking at a loss unless you’ve been invested for a decade or longer. When you open up the insides of what securities comprise your annuity, guess what you will find? Stocks and bonds!
Annuities are simply a big expensive boxes that package plain vanilla stocks and bonds, then stick an ultra-permanent bow on them, and hand the broker a big paycheck for his work in selling you.
You are safe. But you just lost, and the broker won. He’s supposed to be your guy, but his product sale has only guaranteed his livelihood, not yours. Above all, you’ve sacrificed liquidity. If your life changes and you need the money, you’ll likely wind up losing a lot of your investment due to “surrender charges”.
Now, if that annuity were the very best set of securities for you and you never needed something different, then maybe the deal wasn’t so bad. But lives change. Your annuity won’t change with you. And as your life changes and the product is no longer well-suited to you, will you hear regularly from the guy who sold you the annuity? Probably not.
You see, the problem with product sales is that there is almost NO incentive for the broker to continue servicing you. Until you invest more money with him or sell the annuity, he won’t receive any more revenues from you. When the business model is entirely based on a one-time sale, there is less accountability and no fiduciary standard to speak of.
The Good Guys: Fee-only Registered Investment Advisors
The annuity and mutual fund product sales model is very different than what fee-only advisors, who receive a fee from managing your money, provide. Good independent advisors eschew product. They cut your investment expenses in a dozen different places, such as by building a custom municipal bond portfolio for you and by shopping around for the best price. Above all, good advisors are working for their fees by providing service and an ear to you and your family whenever the need arises. Unlike with an attorney, there’s no clock ticking, either.
Benefits of an Independent Advisor
Top investment advisors provide soup-to-nuts service, so that you will never need to call in to deal with large financial organizations again. There is no more tolerating:
- Automated phone support,
- Waiting for an operator
- Or being told you have the wrong department.
Your investment advisor can handle this all for you. Many clients find this to be a tremendous benefit, particularly as they get older, or if they’re very busy.
My Dream
It is my dream that independent investment advisors continue to grow their market share of the financial services business. Neither wirehouse brokers, who are well qualified, nor other financial representatives at banks, insurance or brokerage companies are financially incentivized to minimize your fees. I encourage you to check out independent fee-only advisors who are motivated to minimize your overall fee cost, while providing you great individualized service.
If you would like to know more about the types of financial advisors and the business models under which they work, read our white paper “Choosing an Advisor”
