How Commissions Can Sway a Financial Advisor's Recommendations


In spring of 2005 I was contacted by a retired gentleman who was looking for a financial advisor.  Walter* was a veteran of the U.S. Navy and had a long career in technology in Silicon Valley before retiring.  Walter was a savvy investor, managing his own investment portfolio for decades, but he decided to turn the reins over to a full-time professional.  He interviewed quite a few financial advisors and narrowed the final list down to two firms - ours and a big-box brokerage firm.  What he found was an excellent example of how sales commissions can sway a financial advisor’s recommendations, and how it creates a conflict between the client’s interests and the advisor’s interests, especially the advisor’s wallet.

The big-box firm claimed they would manage his portfolio for $125.00 per year.  No mention of any commissions or other fees, just $125.00.  It sounded like a pretty good deal.  On the other hand, our fees were approximately $4,600.00 annually.  The question Walter asked me was “how could they provide that service so cheaply?  There’s no such thing as a free lunch, so how can they do this?”  He gave me a copy of their investment recommendations and asked me to do some detective work.  As I researched the costs of each fund in its respective prospectus, I meticulously recorded the information in a spreadsheet.

What I discovered was so glaring it shocked me.  More importantly, it highlights the importance of a fiduciary standard between an investor and his advisor.

The first thing I discovered was that all of the funds recommended by the advisor paid her kickbacks for recommending them.  In the mutual fund world these are known as “12b-1 fees” but they’re essentially legal kickbacks.  Every fund recommended was available in another share class with a lower cost, but she recommended more expensive versions to increase her sales commission. 

The second thing I discovered was even more shocking.  The advisor recommended Walter put most of his money into the funds with the highest expenses, thereby paying her the highest commissions.  None of the funds were low-cost index or institutional funds.  That’s either an extraordinarily lucky random draw for the advisor or a clear indication of a conflict of interest.  Which explanation makes more sense to you?

The snapshot below is from the original spreadsheet I used back in 2005 to compile the data. 


This is the heart of the battle in Congress over requiring a fiduciary standard for all financial advisors.  (Monterey Private Wealth has always adhered to a fiduciary standard, both legally and ethically.)   A fiduciary standard requires financial advisors to always put the client’s interests first, outlawing this kind of behavior.  Consumer advocates want all investors to be treated with a fiduciary standard of care, but large brokerage firms have been lobbying against it, as it would seriously hurt their profits.  This real-world example shows exactly why brokerage firms don’t want it.

Some firms will say they put the client’s needs first, but it may be just a slogan or a business practice.  A true fiduciary is a legal obligation, not just a nice idea.  A true fiduciary will put this in writing.

When you buy a car you know the salesperson is going to earn a commission that’s based on the selling price.  But when you go to a financial advisor you’d like to think that they’re doing what’s best for you, rather than what’s best for their wallet.  That’s not always the case, so if you expect your advisor to work with a fiduciary standard of care, it’s best to get it in writing.

*Walter’s name has been changed for privacy purposes.