Most of the time, it’s easy to understand the economics behind the products and services we buy each day. For example, when you buy a sweater, you know that the store has added a profit margin to the price. When you eat out, you get that the server receives an hourly wage plus tip. But when it comes to your financial advisors – the people who give you advice on investments, insurance and mortgages – it’s not always clear what you’re paying and how the person across the table from you makes their money.
The main reason for this is that almost everyone in the financial industry is a commission-based salesperson. No one likes to advertise this fact because, if you follow the money, you might start to wonder whether their financial goals are really aligned with yours.
Here’s a look at some of the various types of financial advisors you might encounter, and what happens when you follow the money:
Financial planning is not a regulated profession, although many of the best planners will have the Certified Financial Planner (CFP) designation. Some work independently, and others work for a handful of dedicated financial planning companies across the country.
If you can find a good fee-only financial planner, the money situation is clear and straightforward. They charge a flat fee to make you a financial plan. You should generally expect to pay a few thousands dollars.
One snag with this approach is you will probably have to keep paying to update your plan over the years. Worse is the fact that you will still have to pay commission-based advisors to actually implement your plan, costing you even more in the end.
Most financial advisors work at bank-owned brokerage firms such as RBC Dominion Securities and CIBC Wood Gundy, or at independent firms like Investors Group and Edward Jones. There are roughly 120,000 licensed advisors in Canada.
Financial advisors can charge commissions for individual transactions and may also charge a fixed percentage of your overall account value. Somewhere around 1% per year is typical. This commission-based compensation means most advisors need to focus a lot of their energy on attracting new clients.
For financial advisors, the moment of truth comes when they must choose between doing what’s best for them versus what’s best for you. That line is not always enforced. For example, mutual funds that paid advisors hefty commissions and charged clients steep penalties for redeeming their money were the bread and butter of the industry for years until regulators clamped down.
These days, financial advisors are required to fully disclose their fees and commissions to you, but it’s important to be aware that they are still not required by law to act in your best interest.
Like financial advisors, insurance agents are commissioned salespeople. The more insurance they sell, the more money they make. The industry has a long sales tradition, with new recruits learning techniques that have been refined for decades.
Many insurance agents are able to shop the market and find you the best rate by comparing multiple insurance companies, which is a good thing. However, when it comes to recommending the correct amount of insurance coverage for your needs, things can get complicated.
On one hand, your agent may be inclined to recommend a smaller policy, since the premium will be more affordable and the sale a bit easier to make. On the other hand, your agent may be tempted to recommend a larger policy, since it will result in a larger commission cheque.
Unfortunately, when you follow the money, there’s no real incentive for insurance agents to do the sometimes complex math required to figure out the policy size that’s ideal for your needs.
There are roughly 11,000 mortgage agents working at brokerages across Canada with names like Verico and Dominion Lending. Many advertise lending rates that are competitive with the big banks.
Once again, mortgage agents are commissioned salespeople. You may be noticing a trend here. Mortgage agents can typically earn a commission equal to 1% of the value of the mortgage they sell.
The tricky part is your mortgage agent generally has the option of discounting their commission to provide you with a lower interest rate. In other words, they are faced with the decision of making more money for themselves or helping you save money. Which do you think they are most likely to choose?
Canada’s big five banks generate more than $130 billion of revenue per year and employ well over 300,000 people. As much as we depend on them for daily life, it’s important to remember that they are extremely successful profit-seeking corporations.
Most of the employees you will encounter at a bank branch are salary-based. However, as recent media reports have made clear, there is still a lot of pressure on them to push you into products and services that are most profitable for the bank.
One of the biggest conflicts for bank employees is not what they say, but what they don’t say. For example, if you qualify for a home equity line of credit at, say, 6% interest, there’s no reason to be carrying a credit card balance at 20% interest. But chances are, your local banker is not going to mention that to you.
All of this may make it sound like the financial industry is full of bad people, but this is definitely not the case. This is an industry that, for 150 years, has used commission-based salespeople to reach out to customers. Today, we have a lot of good people working in an industry with a model that has simply become outdated.
What’s the future?
We believe it’s Planswell. Our financial plans are the best in the world and absolutely free of charge. We do earn fees when you ask us to implement your plan, but our employees work on salary, not commission. This means nobody has an incentive to put their own interests ahead of yours. And you never have to play games. We’ll reduce your investment fees, optimize your insurance coverages, and offer you the lowest possible mortgage rate automatically, without you having to ask.
Try it for yourself. Make a free financial plan that, in about five minutes, can replace all of your other financial advisors, and let us know what you think.