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Follow the Money: Evaluating Financial Advice

When it comes to evaluating investment advice, it pays to be a bit cynical. Asking yourself how the person giving the advice gets paid is always enlightening.

Naturally, this applies to financial advisors. For example:

  • Commission-paid advisors recommend investments that pay commissions (e.g., actively managed mutual funds and insurance products).
  • Advisors who charge based on the size of your account have an interest in convincing you not to use other financial products such as annuities.

But it applies to other sources of investment information as well.

Mainstream Media

If you’re watching a personal finance program on TV, it can be helpful to look at the program’s major sponsors/advertisers.

Is the program sponsored by actively managed fund companies or by discount brokerage firms that make money when you rapidly buy and sell individual stocks? If so, you can see why the program might want to avoid stepping on their sponsors’ toes by saying that buying and holding low-cost index funds is the best way to invest.

Or for smaller, local programs: What do the hosts do for a living? In a recent discussion at the Bogleheads forum, an investor asked why one of the hosts of a local radio program was insistent on her recommendation of actively managed mutual funds rather than index funds.

A little research turned up the fact that the host is a commission-paid financial advisor. Mystery solved. Low-cost index funds don’t pay commissions. Expensive actively managed mutual funds do.

Academic-Looking Research

Even seemingly-unbiased studies can be affected by conflicts of interest. It’s important to find out who did the research. For example, was it performed by:

  • The Chief Investment Officer of an actively managed fund company?
  • Executives at a brokerage firm?
  • The trade organization of mutual fund companies (the Investment Company Institute)?

Any of those scenarios would give you a hint as to why the research draws the conclusions it does.

And just as important: Who funded the research? Was the study performed by professors, but paid for by insurance companies? That might give you a clue about why it says such good things about variable annuities or whole life insurance.

Bloggers

Finally — lest you think that I’m suggesting that blogs are a source of perfectly-unbiased information — let me point out that bloggers have conflicts of interest too.

We make money recommending companies that have affiliate programs. For example, I earn a commission if you open an account at Scottrade through one of my links. I earn nothing if you open an account at Vanguard. For the same reason, it’s more profitable for me to recommend Ally Bank than Bank of America.

Follow the Money

Before making any major decisions based on financial advice, always ask: Who is this advice coming from, and how is this person paid?  You may find that it’s worth getting a second (differently biased) opinion.

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Comments

  1. Great post Mike I couldn’t agree more. As a watcher of CNBC most mornings it is almost laughable to listen to the guests as they either hawk stocks they own or predict the market going up or down which I suspect is at least partially a function of whether their product or service benefits from a particular direction in the market.

  2. Nice job. Great post.

    There is another academic related conflict that is a real thorn in my side. The Securities Industry and Financial Markets Association (an association of businesses that make money from trading activity of others) has made a “stock market game” readily available as a teaching aid for the classroom for free. And teachers eat it up (a free, turn-key lesson plan in world of limited resources and constant budget cuts), teaching their students how to trade stocks in a semester-long, virtual reality, commission-free, and consequence-free (risk-free) environment to build up a false confidence about “investing” that any one of the program’s 650 sponsoring securities firms can one day exploit for profit. They’ve been doing it for over 30 years.

  3. Ugh, yes, the Stock Market Game. Don’t get me started.

    In addition to the dubious lessons it imparts on the students, I’ve actually had a couple email discussions with investors regarding things they “learned” as their kids went through the program in school. I have a suspicion that that’s no accident.

  4. Mike

    one person whom I know who is an advisor told me that if he is advising someone who is just starting out (investing something around like $2k or whatever) since the parent company or whoever he is registered to has some cut in what he gets , so if he doesn’t go for funds that he gets a better commission , the advising is not even worth it (for smaller investments)

    i dont know if i made sense or not but hope you get it.

    so I guess if you are a smaller investor you are better off doing it on your own by reading blogs like this and other investing books..which is what I do..
    ….and happy holidays to Mike and all the other contributors..thanks

  5. Hi Jay.

    Personally I very much agree that investors who are just getting started should try to do it on their own. If they happen to find that they enjoy learning about it and being DIY investors, they can save a lot of money.

    Conversely, if they find that they are not suited to being DIY investors, learning that lesson early with, say, a poorly-invested $5,000 Roth IRA contribution is much better than learning it later with a poorly-invested six-figure 401(k) rollover.

  6. Unfortunately people just starting and doing it on their own may be totally clueless about how to invest. I just sat in on the 401(k) committee meeting at my company and found that 40% of the people in the plan were solely in the money market, some of them at ages 35 and below, a number had only one fund (none having a target), and few were invested enough to get the full match. Sure, it’s their money, but something sounds seriously wrong here IMNSHO.

    As for bloggers, it’s not only conflict of interest but the just plain misinformation that some people put forth as gospel. I’m not going to name names, but there’s one blog I see that seems almost invariably ill-informed, with respondents constantly trying to correct the blogger (who holds to his guns no matter what). Feel free to delete this paragraph if you must, but the situation kind of annoys me.

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