For-Fee Financial Planning Solves the Wrong Problem

I worked on Capitol Hill for a number of years as a reporter covering tax legislation. I once had a boss who imposed a rule that none of the reporters who worked for him could allow anyone to buy him lunch. We had to pay our own way.

The idea, of course, was to prevent conflicts of interest. If someone buys you lunch, you may end up feeling friendly towards him. That might influence your reporting. To insure that your readers get the real story, it’s better following a rule that you always pay for your own darn lunches.

It was a perfectly reasonable policy. I don’t think it did any harm. However, I don’t think it did much good either. Reporters are an independent lot. There aren’t too many of us who can be bought for the price of lunch. This ethics policy was solving a problem that didn’t really exist.

I do not mean to say that the journalists I worked with were not biased. We were. There was another form of bias that affected our work on a daily basis and that no ethics policies ever tried to address.

We all needed information from the congressional tax committees. We had to file stories daily and most of the developments in the tax field took place behind closed doors. If you weren’t on good terms with the committees, you died. The people who worked on the committees didn’t need to buy you lunch to get you on their side. Most of us were willing to sell our souls before we would do anything to get the tax committees mad at us.

The bias that mattered was the bias that was never addressed. In fact, the bias that mattered was so big an influence on our writing that none of us ever spoke of it. It’s common for reporters to joke about how the purchase of a meal might swing them. No one jokes about how they favor the committees that are their lifeline to success as congressional reporters. We were all ethically compromised and we knew it. It was too painful a subject to joke about.

So it is in the financial planning field.

People in this field know that the advice coming from planners is not always top notch. They want to address the bias. One idea they have come up with to do so is to have planners charge a fee for their services rather than be compensated through commissions, which might compromise them in favor of recommending the products and services that pay the biggest fees.

That makes sense. I certainly have no objection to the idea of for-fee financial planners, any more than I have an objection to the idea of reporters paying for their own lunches. Again, though, I don’t think the solution addresses the real problem. The real problem is far more serious a matter than one that can be solved by having planners work for a fee rather than for a commission.

Are there cases where planners have recommended products or services because of the fees they collected by doing so? I don’t doubt that this has happened from time to time. But I also don’t think that most planners are so rapacious that they would recommend products and services solely because of the commissions they are paid for doing. In most cases, the planners are recommending products and services they would recommend in any event. The move to for-fee planners is a positive. But I doubt that it will do much to undermine the bias problem that is causing financial ruin for middle-class investors.

The far bigger bias problem is the pro-stock bias problem.

The academic research shows that stocks offer a strong long-term value proposition when priced reasonably and a horrible long-term value proposition when insanely overpriced. Every time in history in which investors have forgotten this basic truth, they have paid dearly for the mistake. But how many financial planners make a point for reminding their clients of it?

Those who work on commission don’t do it. Those who work for a fee don’t do it. Both types of financial planners are compromised to the core. Neither dares to tell his clients what they need to know to invest effectively.

Again, the bias here is so big that people aren’t even comfortable talking about it. We can imagine a world in which financial planners recommend only goods and services in which they truly believe because they are compensated in such a way that the need for commissions doesn’t compromise them. We cannot imagine a world in which financial planners tell the truth about when stocks are worth buying and when they are not. That would be so big a change in the history of investing that it seems beyond us.

I don’t think it is beyond us. The pro-stock bias has caused four economic crises over the the past 110 years. The idea that there is some mystical, magical, blue pixie dust we can sprinkle into the air to make Buy-and-Hold investing strategies work for the long-term investor has caused more human misery that any other idea in the history of personal finance. The pain caused by this idea has grown so great that things are reaching a point where we will not be able to duck the question anymore.

When we begin talking about the real bias holding back financial planners who would prefer to offer sound investing advice, we will find ourselves making more progress in a shorter amount of time than we ever believed possible. Hire a commission-paid financial planner or hire a for-fee financial planner, It really doesn’t make all that much difference. But be sure no matter what else you do that you hire a financial planner who is well aware of the 30 years of academic research showing that Buy-and-Hold strategies can never work and who is brave enough to resist the intense pressures applied to those working in the field not to to tell the straight story about the dangers of Buy-and-Hold.