Over the weekend>, the Securities and Exchange Commission called for stockbrokers to put clients' interests ahead of the bottom line. But brokers aren't the only advisers who put themselves first. Consumers depend on financial experts of all stripes and many are saddled with conflicts of interest that could cost you money.
The advice industry is booming -- the ranks financial planners, college aid advisers, mortgage brokers and more are expected to increase by 30% by 2018, to 271,200, according to the Bureau of Labor Statistics. But many of these advisers get paid to peddle specific products, or to encourage consumers to make risky decisions. Among the conflicts: Insurance agents and some financial planners often get the biggest commissions by selling products that can result in smaller savings for consumers. Mortgage brokers profit by originating larger mortgages even if a buyer has a tough time making payments. And college financial aid advisers rake in fees of up to $1,000 or more to boost financial aid, rarely delivering more than what a family can do on their own.
Of course, no one sets out to get bilked. Many consumers even second-guess advice, then push their worries aside, says Linda Sherry, director of national priorities at Consumer Action, a nonprofit advocacy group. One reason: A surprising number of people believe -- sometimes mistakenly -- that financial professionals are acting in their best interest: 76% of investors said so for financial advisers and 60% said the same for insurance agents, according to a September 2010 study co-authored by the Consumer Federation of America. The truth, however, is another story, says Barbara Roper, CFA's director of investor protection. Many, she says, are "salespeople with no obligation to act in the best interest of the customers."
Here are some warning signs to look for when working with four types of advisers.
Fee-only advisers don't sell products, and therefore don't have commission incentives (they charge a flat or hourly fee or a percentage of assets under management, or both). But other financial planners depend on commissions that come from selling products, others charge fees or get a percentage of assets--many use a combination of the three. One big pitch to watch out for: variable or equity-indexed annuities where high commissions often eat into returns. The same tax-deferred retirement saving benefits occur with an IRA or 401(k) often for a tiny fraction of the fee, says Roper. Planners make up to four times more in commission (about 5% to 8%) on average by selling a variable annuity than investing a client's money in mutual funds, says Sheryl Garrett, a fee-only certified financial planner. Invest $3,000 a year in an index fund with a 6.75% net return and you'll have $40,000 more after 25 years than if you put the same money in an annuity at 5% net yield.
What to do: Make sure you understand how fees and performance on funds you are pitched stack up to other funds with similar exposure. (Many people don't: About 32% of women and 23% of men rely solely on a financial adviser's recommendations for mutual funds, according to the CFA.) You can also ask if the fund is owned by the company selling it or if the broker gets paid extra for selling it, says P.J. Gardner, founding partner at AGW Capital, an investment consulting firm, but there's little guarantee that they'll tell you.
Because agents depend on commissions to make money, they may pitch policies that serve little purpose. "As a whole, the insurance industry is very much 'buyer beware' territory," says Roper. What to beware of: child life insurance and cancer insurance, says Scott Simmonds, a Saco, Maine-based insurance consultant. Life insurance policies protect the income of breadwinners, but children don't make money. To sign up for cancer insurance, which provides cash for cancer treatments not covered by health insurance, a consumer must be healthy but assume they'll be among the nearly 41% of adults to be diagnosed at some point, according to stats from the National Cancer Institute. The average monthly premiums for cancer insurance range from $20 to $36 a month, according to eHealthInsurance.com, which means you could pay $432 for every healthy year. Life insurance, long-term care and disability insurance, on the other hand, can be smart--but brokers will often try to sell you pricey policies that net them more cash.
What to do: Most adults should have a life insurance policy, but in most cases, a term policy is the best option, says Simmonds. Premiums are about 70% lower than on a whole life policy, he says. Commissions on whole life can run up to 110% of the first year premium. If you sign up for long-term care or disability insurance, make sure the insurer is in good financial health (try ratings agencies A.M. Best Company or Weiss Ratings) because if a company shut down, policyholders could lose coverage, says Simmonds.
As of now, mortgage brokers can earn extra cash from the lender they sell the loan to for adding terms like a prepayment penalty. In April, new Federal Reserve rules for mortgage brokers will put a stop to that, but buyers will still need to look for questionable tactics, says Robert Lattas, a real estate attorney in Chicago, including pushing a customer into a bigger mortgage. The result: a buyer with, say, a $70,000 down payment might be persuaded to put less money down than the typical 20% recommended, in order to get the $380,000 house -- on which a broker will earn a bigger commission. The broker's share, which ranges from 0.5% to 2% of the mortgage, gets bigger as a loan grows.
What to do: It's a good sign if a mortgage originator asks about monthly income and expenses and whether large expenses, like private school tuition for children, will kick in while repaying a mortgage, says Gibran Nicholas, chairman of the CMPS Institute, which trains and certifies mortgage lenders and brokers. If they don't ask -- or don't care -- consider these expenses yourself before signing up for a mortgage that gets you an extra bedroom now and financial strains down the road.
College aid advisers
Newly-minted college graduates carry more than $23,000 in student-loan debt, on average. As college costs climb and more families scramble to get financial aid, financial aid consultants have become sought-after advisers. "The main benefit is hand-holding," since they mostly help fill out the Free Application for Federal Student Aid, says Mark Kantrowitz, publisher of FinAid.org. However, many also claim they can increase financial aid, which often cost $1,000 or more which is simply untrue.
What to do: Once the FAFSA is filed, there are no strings to pull to get more federal, state or school aid--other than appeal to a college's financial aid office, which families can do for free. And parents who are saving with a 529 plan should consider signing up for a direct-sold plan where annual fees are nearly half what they are for adviser-sold A- and single-share plans (0.59% compared to 1.16%, on average), according to the Financial Research Corporation. Most direct-sold plans offer age-based options that become more conservative as time goes by, minimizing your risks.