Conflicts of interest in the financial industry

In my recent column in the Edmonton Journal, I highlighted one of the conflicts of interest when it comes to the financial industry giving debt advice vs selling debt products.  Some people thought I would really anger the financial industry but I have not heard any comments of the sort.

Here are some other examples of questionable advice coming from the financial industry because of conflicts of interest.

Pay off debt or invest?

Tammy received a $350,000 inheritance and her Aunt who was the executor of the estate suggested she use the money to pay off her mortgage of $210,000.  When she went to the bank to pay off the mortgage, they suggested that since there was a penalty to pay off the mortgage, she would be better off investing the $350,000 because the mortgage interest was locked in at a low 2.9% interest rate for the next 19 months.  Was this advice really in Tammy’s best interest or was this advice in the banks best interest?  That’s where the conflict of interest comes into play again.

Compensation of GICs vs mutual funds

Marie is 68 years old and is tired of the volatility of her balanced fund with Great-West Life.  At 68 years of age, she wants something more secure and she does not want to open up her statements and see losses.  She goes to her financial advisor to move the money to a GIC.

Unfortunately for Marie, she is talked out of a GIC and convinced to stay put in her balanced fund for a myriad of reasons you have already heard before:

–       Don’t panic and sell at a loss

–       Hang in there because eventually it will come back

–       GIC rates are low and after taxes and inflation you will lose money

Some of these arguments may make sense but does conflict of interest come into question?  Did you know the GIC pays one fifth of what the mutual fund pays in commission?  It’s possible the advisor sincerely, believed he was doing the right thing for Marie but it may also be fair to bring up the potential conflict of interest that comes from the different commission rates in the products.

Why won’t my advisor sell Exchange Traded Funds?

Jon and Irene have some friends that have decided to move out of their mutual funds and into Exchange Traded Funds (ETFs).  ETFs are appealing because they are low cost investment products.  Their friends showed them some compelling research showing how higher fees puts investors at a disadvantage.

Why didn’t their advisor suggest ETFs?  Most ETFs are lower cost because they either have lower compensation or in most cases, NO compensation built in for the advisor.  As a result advisors must either charge a transaction fee to get compensated or they have to charge a discretionary fee directly to the client.

What’s best for Jon and Irene really depends on the value provided by the advisor.

Leverage is sold, not bought

Larry works in the Oil industry and although he makes good money, he also knows how to spend it.  The problem is at 39 years of age, he has little to show for his hard work and good income.

Larry meets Ross, a financial advisor and suggests that Larry should get a line of credit and use that line of credit to invest in a portfolio of mutual funds as a way to catch up on his wealth.  Larry would borrow $75,000 and make payments of $350 per month to cover the interest and these interest payments would be tax deductible.

Larry’s conservative father-in-law suggested he just invest $350 per month and forgo the line of credit.  Ross showed Larry a projection where the investment return was higher than the cost of interest and as a result he would be far better off with the leverage program.

Larry took the advice of the financial advisor and unfortunately, the investments did not perform as well as expected.  The conflict of interest comes when we look at Ross’s financial results. Ross made money by selling the line of credit.  He also made money on the investment.  Ross made $3000 up front plus he makes $300 per year.

If Larry put away $350 per month into a mutual fund, Ross would make $168 per year in commission which is much lower that the $3000 he made up front.

Who’s the real winner in these scenarios?

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Group Benefits Online and Advisor Think Box.

4 Responses to Conflicts of interest in the financial industry

  1. Great thoughts. Noble intentions always hit the wall when you’re starving. You just can’t Advise and Sell products without conflict creeping in at some point.
    Using leverage as a tool to sell products is dangerous and a short term strategy for desperate advisors. But I think you dismiss leverage too quickly.
    There is a better and far more creative way to use Leverage within a larger Financial Process. As a stand alone investment strategy you open yourself up to the down side of risk. However, as part as a process that will restructure debt and attract additional cash flow into your Financial Life Plan, you now have a tool that increases your life’s Affordability. With a better understanding of the math, leveraged investing can preserve the dreams of the middle class with far less risk than diversified portfolio.

  2. There’s a fine line when it comes to genuine advice or a conflict of interest. An advisor’s role may be to talk you out of doing something foolish with your money, even though that’s what you want to do. However, when the advisor stands to gain or lose a hefty commission because of your actions, it crosses the line into conflict of interest.

    Someone who can’t stomach the volatility in the equity portion of their portfolio maybe wasn’t assessed for risk properly.

  3. There are too many conflicts of interest in this industry. The ratings companies are paid by the companies they’re supposed to rate, so obviously the ratings will be good! The brokers are paid based on commission, which means that they don’t care about how much money you make, they only care about how many times you invest.

  4. Good post. Great topic. I think people are just frustrated. Unless you really take the time and learn yourself, it’s hard to break away from these products and trusting someone you should not.

    Please keep sending this message as much as you can.

    I’m presently trying to shop for a lower fee group pension plan for my workplace. This has proved to be extremely difficult. Almost every company offering GPP’s are carbon copies of each other. Ask for lower fee funds or some alterantive – you getting the sound of crickets on the line.

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