Your Broker May Not Be Working in Your Best Interests

Your Broker May Not Be working for You

Richie Capital Group specializes in discretionary investment services for Institutions and Individual Investors.  Our investment goal is to maximize client returns over time through an established investment process. We invest money on behalf of our clients and typically do not focus on providing individual comprehensive financial advisory services. However, to bring in clients over the past year, we have gladly performed these services for many who have asked. In this process, we have gained greater insights into the broader world of Financial Advisory Services (Brokers, Investment Advisors, and Wealth Management firms). There are many outstanding companies providing advisory services. But in most other cases, we have come to the conclusion that…. they may not be working in your best interests.

There’s an old saying that goes, “Show me how someone is compensated, and I will tell you how they will behave.”

This is true in any area of business whether it be electronics store employees who receive a payment for every customer that buys an extended warranty or department store salesclerks who earn a small bonus for every new credit card customer they sign. People will operate in a manner that maximizes their personal utility. A case study for this phenomenon can be found in the recent Wells Fargo scandal[1]. Wells Fargo acknowledged that for at least 5 years, thousands of low-level employees set up unauthorized customer accounts to meet difficult sales quotas and also so that the employees could receive larger bonuses. The company had set an internal goal of selling at least eight financial products (checking accounts, savings accounts and credit cards, etc.) per customer. This combined carrot and stick motivation led to a culture that encouraged employee misbehavior. The bank recently revamped their employee compensation[2] plan to better align company interests with that of customers.

There are similar motivations in the world of financial advisory services. A financial advisor is generally compensated through fees, commissions, or a combination of both. Typical compensation structures include:

  • An hourly fee for advisory services
  • A flat fee, such as $3,500 per year for an annual portfolio review or $5,000 for a financial plan
  • A commission on the stocks bought or sold, such as $8 per trade
  • A commission (or “load”) based on the amount invested in a mutual fund or other product
  • A “mark-up” or “mark-down” on products when they are bought or sold
  • A fee for assets under management, such as 1% annually of assets managed

Each of these compensation schemes would incentivize an advisor to behave in a way to maximize their personal profit. At brokerage houses, most brokers/advisors are compensated via commissions based on specific products sold to clients. If a firm wants certain products sold at a higher volume, they increase the commissions paid to sales staff on that particular product. Of course, the brokers then focus more attention on selling you, the client, this product that you may not really need or which may not be the best product available to meet your needs. But the broker will find a perfectly logical rationale for the purchase! The reality is that the broker believes it’s a great fit for you because the commissions on the product are outstanding!

Other broker behaviors born of compensation structures include:

  • Portfolio Churning – Defined as excessive trading (buying and selling stocks) by a broker in a client’s account primarily to generate commissions. Churning is both illegal and unethical and violates SEC rules and securities laws[3].
  • Reverse Churning – The practice of a financial advisor placing an investor’s funds in a fee-based account for no reason other than to collect the fee. These accounts are charged a regular fee, but typically receive very little advice, trading, or account activity. Therefore, the firm generates more revenue while the customer does not receive any recognizable benefit.
  • Recommending Higher Fee Products – Advisors do this even when lower cost (and often better performing) products are available.
  • Double Dipping – When a broker puts commission based products into a fee-based account. The broker makes money from both the client through annual fees on the account as well as from the commission on products sold into the account.

On April 6, 2016, the U.S. Department of Labor issued its final “Fiduciary Rule[4]” to eliminate incentives that might cause brokers to give conflicted advice. The new rule will require all who provide retirement investment advice to abide by a “fiduciary” standard—putting their clients’ best interest before their own profits. In other words, this Fiduciary Rule now makes it a legal requirement for investment advisors to work in their client’s best interest and any conflicts of interest must be disclosed.

Pause for a moment to consider the fact that the investment advisory industry needed a rule in place to require brokers and advisors to act in their clients’ best interests…..

 Previous rules only required that brokers’ advice be “suitable” for a client.

What has been the impact of the new rule thus far?

Many investment firms are making internal changes. A recent news release provides a hint at the potential impact on profits within the industry: LPL financial decided to put itself up for sale[5] after assessing the new rules. This decision signals that LPL management realized that being forced to comply with the new regulations would make their business less profitable to the point that their business might be better suited if combined with another company.

Side note: Post-2016 election results, there are rumors that this new rule may be delayed or repealed by the incoming presidential administration. Potentially, the rule may be implemented in a watered down form or compliance deadlines may be delayed.

Motivations drive behaviors. And we see that in the products being sold into the markets. However, we have seen other patterns while reviewing new client portfolios. Here is a sample of a few other practices we have seen that you, as a customer, should be on the lookout for:

  • Hidden Fees – Financial advisors are compensated using the methods listed above. You should also search for “hidden” fees. These are fees that are not clearly disclosed up front and get wrapped into the price of the products being sold. You buy a product but do not realize that you immediately lose 2-10% of the value right off the top. This product may also charge additional ongoing maintenance or operational fees.
  • Poor Diversification – We see many portfolios constructed of multiple mutual funds. These funds are often chosen to provide varying levels of “diversification” which are not relevant to the client’s situation. Any one of the funds individually would likely provide sufficient diversification. But multiple funds with 150+ stocks in each fund can be overkill. Additionally, the funds aren’t always the best performing within their category and were likely chosen because of a financial arrangement between the brokerage firm and the fund providers. Clients are typically better off placing their money into a broad ETF that tracks the market and has almost zero fees.
  • Illiquid Investments – This category includes Annuities, Long term CDs and any other investment that locks up your hard earned cash for long periods of time. The products cannot be redeemed without significant penalties. Typically, these products are pitched as “safe” or “guaranteed return” long-term investments. They may be safe and the returns may be guaranteed, but you should be compensated with an attractive risk/reward based return for the inconvenience of not having access to your cash for long periods of time.

Unlisted REITS or Non-traded REITS

This is a category of illiquid investments that deserves its own separate section. Non-traded REITs sell shares to investors and use the proceeds to purchase properties, which they develop, managed and sell for profit. The REITs usually pay dividends and investors stand to profit when the managers sell the properties in the future. Non-traded REITs aren’t listed on public exchanges and are usually sold through brokers. These products are typically sold to customers as attractive investments that will generate high returns over a 7-10 year period. The fees aren’t always clearly disclosed and the upfront fees are typically in the 11% range. (i.e. only $8,900 of a $10,000 investment was invested into properties). During the investment period, the value of your holdings is not updated frequently. You may only get a new assessment of your portfolio value on an annual basis with no detail on how the valuation was assessed. And you may never really know the value of your investment until shares are redeemed many years in the future. At that point, you will likely have forgotten how much you paid or what return expectations you had in the first place. The broker who sold you the shares may no longer be managing your account. And if some emergency arises prior to redemption, there is no market for your shares. Only the issuer can purchase the shares from you and they are unlikely to buy your shares unless you are willing to sell them at a significant discount (think 20%+). You should be asking why purchase an unlisted REIT when there are plenty of high quality, publicly traded, liquid REITs with a history of performance? These publicly traded REITs require quarterly disclosures and are regulated by the SEC. The big question I have for the sellers of these non-traded REITs, how do you know that the issuers are really good at real estate investing? As a customer, you will find out 7 -10 years from now[6].

How can you tell if your financial advisor is working for you?

You have to ask questions. If you are already working with an advisor, you should begin by asking yourself: What were my goals when I started this relationship and how much progress am I making towards that original goal?

Next, how are they compensated? And you should understand that compensation with every single transaction they pitch to you. How do you (or your firm) make money off of this? And then consider whether that payment scheme compels them to operate with your best interests in mind.

When a product is pitched to you, you should wonder if they are buyers of the product as well. Do you own any of this? Would you sell (and have you sold) this product to your mother or grandmother?

Not every conflict of interest can be avoided, but they can be mitigated. Richie Capital Group is different. We are investors, and our firm was born out of a passion for investing that is built into our culture. Our founder began investing decades ago with the goal of becoming an outstanding investor and to build personal wealth. As performance and ability improved, he realized that there were many potential clients who could benefit from the things that he did well. Since RCG opened our doors to clients, our goal has remained the same: we strive to help our clients build wealth through investment.

We have put a few key structures in place to mitigate conflicts of interest:

  1. Our firm is structured as a Registered Investment Advisor (RIA) – An RIA must adhere to a fiduciary standard of care laid out in the US Investment Advisers Act of 1940. This standard requires RIAs to act and serve a client’s best interests with the intent to eliminate, or at least to expose, all potential conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not in the best interest of the RIA’s clients.
  2. We eat our own cooking. – We invest along side our clients with all employees investing in the same strategies and businesses that our clients invest in. When our clients do well, so do we.
  3. We charge a flat fee for the majority of our products and there is no incentive to move client portfolios from one product to another unneccessarily.
  4. We benchmark our performance. Our focus is on long-term returns and we measure ourselves against free alternatives in the market. (e.g. passive ETF indexes). We seek to outperform these benchmarks, net of fees, over the long term.
  5. Sound investment strategy – We invest in outstanding companies and we bring a wealth of business analysis expertise acquired over decades of education and market study.

Feel free to contact us for questions or more information:

[3] There is no quantitative measure for churning. Frequent buying and selling of securities that does little to meet the client’s investment objectives may be construed as evidence of churning.
[6] “Why Investors Should Think Twice About Nontraded REITs”, November 2015, (


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