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These are common financial advisor conflicts of interest.

If you’re working with a registered investment advisor (RIA) firm or financial advisor, you’ll likely encounter some conflicts of interest that arise from your advisor’s compensation arrangements. Some advisors have legal obligations to disclose such conflicts, but others don’t. When researching a firm or an advisor you’re interested in, it’s useful to review legal documents that describe each advisor’s practices. These typically provide more information about the firm’s advisory services, fee structures, investment strategies and disclosures. If you’re still searching for an advisory firm or professional, our free financial advisor matching service can help. Below, we’ll explore common advisory conflicts of interest, as well as other factors that influence whether you’ll encounter any. 

Conflicts of interest generally arise when the financial goals or interests between advisors and clients don’t align. In many advisory relationships, financial professionals sit down with clients to identify investment objectives, risk tolerances and time horizons. Clients can also specify any investment limitations or restrictions, but advisors generally hold the discretionary authority to make financial decisions on behalf of each client.

But how do you find an advisor’s conflicts of interest? A more DIY-based approach is to review the financial advisor firm’s Form ADV. A Form ADV is paperwork that all advisory firms registered with the U.S. Securities and Exchange Commission (SEC) must complete. The paperwork has two parts. Part I outlines each firm’s client base, assets under management (AUM), office locations, fees and disclosures. Part II contains a firm brochure that the firm itself writes. The brochure essentially outlines the advisor’s investment strategies, advisory services, industry affiliations, fee schedules and conflicts of interest. Fortunately, both parts are publicly available. You’ll be able to use this to your advantage if you’re working with an affiliated advisor of an SEC-registered firm.

What are Some Common Conflicts of Interest?

These are common financial advisor conflicts of interest.

Advisory firms with fee-based fee structures often have affiliations with registered broker-dealers and/or insurance agencies. This allows firm representatives to earn commission-based compensation from selling insurance or investment products, creating a conflict of interest if advisors recommend securities or products that don’t align with a client’s best interest. It’s important to note that this form of compensation is in addition to asset-based fees.

Performance-based fees can also create a conflict of interest if the advisor participates in side-by-side management of performance fee accounts and asset-based fee accounts. When it comes to investment opportunities, advisors may become incentivized to favor accounts with higher fees over other asset-based accounts with lower fees. Fiduciaries often disclose such conflicts of interest, regardless of their fee structure.

Fee-only vs. Fee-based: What’s the Difference?

Fee structure is often a reliable indicator of whether your advisor will have any conflicting advisory practices. The two most common fee structures are fee-only and fee-based. If your advisor has a fee-only fee structure, they’re compensated solely for the advisory services they provide and not for the investment products or money managers they sell or recommend. This also means that they don’t earn commissions. In providing financial services, fee-only advisors earn compensation through a percentage of client assets.These advisors also charge flat fees and/or hourly fees.

Fee-based advisors typically earn commissions in addition to the asset-based fees collected from clients. As mentioned earlier, these commissions generally come from insurance or investment products.

Fiduciary vs. Non-fiduciary Advisors 

A fiduciary standard is a legal obligation that requires financial advisors or advisory firms to work in each client’s best interest. All SEC-registered investment advisors and advisory firms have a fiduciary obligation, regardless of fee structure. In honoring the legal standard, advisors must disclose any conflicts of interests. Non-fiduciaries usually operate under a different standard.

Examples of non-fiduciaries include, but aren’t limited to, broker-dealers and broker-dealer firms and insurance agents. These advisors are typically registered with the Financial Regulatory Insurance Authority (FINRA) or state insurance regulators. Whereas fiduciaries must honor a fiduciary standard, non-fiduciary broker-dealers normally abide by a “suitability” standard. Unlike the fiduciary standard, the suitability standard only requires financial professionals to provide advice that is most suitable to a client’s needs.

Bottom Line

These are common financial advisor conflicts of interest.

With the assistance of a financial professional, you can significantly grow your wealth over time. But you’ll want to take note of factors such as the firm or advisor’s compensation structure and/or conflicts of interest. Financial firms and advisors with fee-only fee structures generally have a lower potential for conflicts of interests than fee-based advisors do. This is mainly because fee-only advisors don’t earn additional compensation from other products. In narrowing down your search, remember to determine whether your advisor honors a fiduciary or suitability standard. Though the two standards apply to different professionals, both ensure that advisors make investment and financial decisions according to your specific needs and interests. When it comes to investing, retirement planning or financial planning, a fiduciary may be the better choice. Even if your advisor has conflicts of interest, their fiduciary obligation will protect your assets over the long-term.

Tips for Finding the Right Financial Advisor 

  • Do you seek assistance in investing, or is it estate planning or tax planning you’d like help with? Before choosing an advisor, it helps to identify your risk tolerance, short- and long-term goals and time horizon. Compensation structures and disclosures are other important factors to review as you compare potential advisors.
  • If you’re still having trouble narrowing down your search, SmartAsset’s free financial advisor matching tool connects you with up to three local advisors. You’ll simply need to complete a short questionnaire about your financial preferences, and the tool pairs you with advisors within minutes.

Photo credit: ©iStock.com/SbytovaMN, ©iStock.com/skynesher, ©iStock.com/wutwhanfoto

Rickie Houston CEPF® Rickie Houston writes on a variety of personal finance topics for SmartAsset. His expertise includes retirement and banking. Rickie is a Certified Educator in Personal Finance (CEPF®). He graduated from Boston University where he received a bachelor’s degree in journalism. He’s contributed to work published in the Boston Globe and has worked alongside award-winning faculty for the New England Center of Investigative Reporting at Boston University. Rickie also enjoys playing the guitar, traveling abroad and discovering new music. He is originally from Wilmington, North Carolina.
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