I was reading the brochure for a travelling tailor today and I came across a statement that made me think about how people enter the field of financial advisory. The reason that this brochure piqued my interest was that the founding tailor of the company had "spent his early years learning the art of tailoring." This man had started his business in 1961 equipped with the knowledge and skills that he had learned. I started thinking about other people that I know who have started businesses. A friend of mine owns his own engineering firm; he started it after working for a large employer for three years. If he had tried to open his own firm right out of school he would not have had the applied skills or experience with clients to successfully operate a business. I do know a lawyer that opened his own shop as soon as he had passed the bar, but lawyers are required to article before they can practice. I have another friend that just finished medical school; after four years of classroom education, he has to complete another four years of residency before he is able to practice. All of these people work in a capacity in which they hold themselves out as a professional whose advice should be taken due to their extensive expertise and training. Financial advisors hold themselves out in the same way, but the level of training and expertise that is expected from a professional is not always present. The 'best' financial advisors are not necessarily the people that are able to give the best financial advice, they might just be the best salespeople. To be fair, everyone is selling something. The difference between a lawyer and a mortgage broker is that one is selling their expertise, while the other is using their expertise to sell a product. So what is your financial advisor selling? This is becoming one of the most important questions to ask.
When a new advisor enters the business it is far more common for them to receive sales training than advisory training; new recruits are taught product knowledge and sales psychology. Performance is not measured by the quality of financial plans being produced, but by the level of sales. To the credit of many hard working people, it is possible to get through sales training, get a client base, and become a well educated financial professional that is truly able to help people. The issue that I have is that it is left up to each individual advisor whether they want to be a true advisor or a salesman; both have the potential to build a rewarding career. It is possible to gain some insight and clarity into what advisors are selling when the way that they are paid is examined. There are three main ways that a financial advisor can be paid:
- Commissions - the advisor is paid commissions by a third party for selling their product. The client does not directly pay the advisor.
- Fixed fee - the advisor and the client agree on a percent of the assets being managed that will be paid to the advisor for their service. The client is in full agreement with how much the advisor is being paid.
- Hourly rate - the advisor will charge per hour of advice, much like a lawyer would charge for billable hours. The client is paying a one time fee for the construction of a plan, but has to pay hourly each time they need further advice.
It is very clear that an advisor that is paid by commissions is selling products. Issues quickly and readily arise when financial companies begin competing for the business of advisors by offering more attractive compensation. Commissions are paid to the advisor by the financial company, but the money is coming from the management fee that the client is paying. This form of compensation has a major problem because the advisor's compensation is not explicitly disclosed to the client. This is issue has not gone unnoticed by regulators; fee disclosure to clients is a reality, and the future of embedded commissions is in question. With embedded commissions, trailer fees in particular, clients are not always aware that they are paying a fee for ongoing service, and as such they do not demand the service that they deserve.
Both fixed fee and hourly rate financial advisors have an agreement with the client that determines how much the advisor is getting paid for their services; this type of arrangement ensures that the client is explicitly aware how much they are paying their advisor.
An advisor that is being paid directly for the advice and guidance that they offer is much more likely to need to spend time developing their knowledge and skills before they are able to begin offering their advice. An advisor that is being pushed by their sales manager to sell financial products is less likely to develop the professional skills and knowledge that they should have to service their clients and more likely to look for their next sale. The argument can be made that people need to be sold financial products because they are not motivated enough to buy them on their own, but to counter this argument I believe that when the goal of the advisor is not to sell financial products but rather to sell professional advice, clients will be knocking on the door.
If doctors had sales managers in their offices, and the sales managers compensation was tied to the amount of prescriptions the doctor wrote, it would be safe to say that there would be a lot more prescriptions being filled on a daily basis. Financial advisors are a valuable asset in anyone's life; they fit in with accountants, lawyers, and doctors in their capacity to use their knowledge and skills to help people. To truly operate as an advisor, however, takes a significant amount of dedication, time, and effort. As this ageing industry begins to pass to the next generation, it is more important than ever for young advisors to find the mentorship that they need in order to maintain the level of professionalism and pride that should exist in this career.