The system.

At Nav.it, we talk a lot about how we live in a system. A school system, a food system, an environmental system, a government system and…among others, my favorite: a financial system.  

They are all interconnected and small ecosystems that create the whole. However, in the U.S., almost all other systems are fueled by the financial system– so it is the core of what we need to understand to nav. the world we live in. I know it can all seem boring, but here is an example of a current high stakes drama that can show you how our financial system works.

The “Fiduciary Rule” 

When you start to make money, you start to have investment options. Usually that’s in the form of a 401k sponsored by your employer. That 401K is sold by a financial firm to your employer and your employer usually pays a fee to that firm for them to manage your money. There are sometimes also fees paid by you from your portfolio. Don’t be scared by all this, just be aware and research it if you can. 401ks are a great way to save for retirement (especially if your employer is matching your contributions-“free” money right there). 

As you get older, you may start to accumulate savings and –after paying off (or down) your debt and setting up a healthy emergency fund, like the responsible person you are:)—you may have a little extra cash to invest.  This usually means you put it in the stock market–or bonds, or money markets, etc, unless you are more interested in real estate or other business ventures.

The Process of financial system. 

So, how do you actually invest in the stock market anyway?  Well, most people give their money to a financial advisor, financial planner, a bank with a financial investment advisor, etc., to put into an investment or two and watch it dip and grow over time.  People have historically thought of this as “retirement planning”–when you will want to live on your investments instead of working for income. 

Now, more and more people are investing themselvesHowever, the standard middle- to upper middle-income person in the U.S. still gives their money to an advisor.  Since we know our system is all about the money (cue Jessie J rebuking the music industry) the question is, how do those advisors get paid?  

Financial Advisors and Their Pay.

Typically, a commission-based or fee-based advisor gets paid based on a percentage of your investment (say 1%-5% of your overall assets annually) AND sometimes, by a commission from the investments they chose to put your money into.  Get it?  It means that instead of staying in the market and working for you, that money take out annually to pay him/her for managing your investments. Depending on the advisor, some also get an extra commission for selling you a product.  The catch (and the crux of the current fight) is that they can sell you an investment that they financially gain from (through a commission), even if there is an equivalent product with no commission attached.

Upselling someone for your personal gain without disclosing your benefit is usually called a conflict of interest.  Depending on the industry, there are laws that require a salesman to keep the best interest of the client, and not themselves, in mind.  But apparently not in this industry.  It’s why people who know about finance always recommend a fee-only Certified Financial Professional (or CFP), because they charge you a flat fee upfront and don’t get paid on a commission or percentage of your portfolio.

What’s happening right now?

So, drama, drama, drama.  There is NO SUCH rule as stated above in the U.S. It’s legal for financial advisors to place people in investments that may or may not be in their financial interest.  This article from the Dailyworth explains it well. 

Bottom-line, a rule was passed by our Congress that should go into effect in April 2017 (in two months) that requires all financial advisors, brokers, planners, etc–basically anyone giving financial advice and selling financial products–to place the best interest of the client ahead of their financial benefit. Seems simple, right? Well, the new administration has challenged the rule and is trying to block it. They argue that high commissions help advisors serve people with lower assets, and that the regulation will disallow advisors to serve low- or middle-income individuals.  But basically, if this is enacted, commission-based advisors will take a significant hit in their personal revenue.

The Point.

I could go into more details, but the articles listed above can give you more information about the rule, if desired.

The point is : See how important it is to pay attention? If people can use your money to gain economically, doesn’t it make you want to a) watch to see if the fiduciary rule is upheld, so you know your rights in the future, and b) be very careful in the investment advisor you choose. Ask them how they get paid. Ask if they get a commission off the product they are selling you. Calculate how much you could have made on the money you had to take out of your investment and give to her/him. At the moment, just because you work with a big-name company doesn’t mean they have your best interest in mind, and that’s perfectly within their rights.

It may also make you want to: c) learn more about investing yourself, which comes with less fees and more money in your “portfolio” (i.e. investments) working for you! That usually means you set up a brokerage account with an investment firm,–the most recommended is Vanguard, because of their low fees and investor-owned structure, but there are others–give them your money directly, and choose the types of investments you want to invest in. These groups usually have people you can talk to about it, and questions to help you navigate investing— it’s not as scary as it sounds because if you want to learn it, you can.

How to Nav.it.

It’s your choice about how you invest, but knowing how the system works will greatly assist you.  If you don’t feel comfortable investing yourself, having an advisor is a totally viable option.  What I hope you take away from this article is that you have to be very careful choosing your advisor. Ask about pay structures and calculate how much that will cost you in the long run. If you can, look for CFPs who are fee-only.

And if you think the financial system is boring, watch how this Fiduciary Rule plays out in Congress and you’ll get a taste of some real-life drama, all about finances.  Don’t be fooled by the big language, commission-based advisors and banks are arguing the rule will cost the economy money and the regulations are overreaching, the other side says the time has come to ensure more transparency in the industry.