“In Financial Advisers I Trust”, or Should You?

Conflicts of interest occur everywhere and are an unavoidable side effect of our capitalistic society. This can be in the form of doctors prescribing medication that reaps them the highest profit margin or even external auditors who are tasked with auditing a company that is, in fact, paying them for the job.

These scenarios occur everyday and in all walks of life. The financial industry is not immune to these foibles. Brokers and financial advisors are tasked with providing good investment or money advice.

However, they may not always have client’s interest at heart. Like anyone else, they are driven by profit and this could directly contradict what the client needs. I’m not saying that all conflicts of interest lead to mismanagement or poor advice but we should at least be wary that it exists.

The extent of the problem

The White House estimated that Americans lose $17 billion a year due to conflicts of interest between financial advisors and their clients. This could in fact be a very conservative estimate, as experts believe that this figure should in fact be very much larger.

An article on Bloomberg reported that an average of eight percent of advisors have a record of serious misconduct. And nearly half of them kept their jobs after being caught. Financial advisors also typically seek out the less educated and retirees whom they can gain their trust more easily.

These are damning statistics that emphasise the need for education and a way to regulate a system that costs retail clients billions of dollars a year.

The complexity of investment products and the sometimes intentionally vague financial jargon means that even seasoned investors are not immune to bad advice from financial advisors.

Advisors or sales representatives?

Financial advisors are motivated by commissions they earn from selling financial products to their clients. These commissions vary considerably. For instance, insurance products tend to offer advisors a greater commission compared to unit trusts or stocks.

This obvious difference in pay structure can lead to advisors offering insurance as an option more often even if it does not fit the client’s needs.

This begs the question – are financial advisors really advisors at heart or just merely a sales representative?

If clients realise the existence of potential conflicts of interest between them and the advisor, they will be more wary of the advice they receive. If we regard them, more as someone who offers information on products instead of advisors, we can at least make better investment decisions.

Experts argue that in order for clients to have a better grasp of the situation, fees need to be more transparent. Some have even recommended changing the pay structure all together.

The Foolish bottom line

Incentives are bound to encourage unethical behaviour in any industry. However, if we, as consumers are aware of all the possible conflicts, we can at least make better decisions.

For the case of financial advisors, these conflicts of interest exist to varying degrees. Some advisors are upright and moral and constantly put clients needs over their own. However, there are bound to be those who are there just to make a quick buck.

As investors, we need to be wary of dealing with them and to constantly educate ourselves so that we can make sound investment decisions.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.