Why there is no conflict of interest between financial planners and clients
January 24, 2013 by David Lewis
If an advisor values his business and his clients, then how do his personal interests clash with those of his clients? Answer: They don’t.
It’s not uncommon for industry organizations to claim that financial planners must balance “conflicts of interest” when working with clients. For example, the Certified Financial Planner Board of Standards states, in it’s code of ethics, “Fairness requires impartiality, intellectual honesty and disclosure of material conflicts of interest.”
What does the CFP board consider a conflict of interest?
“Conflict(s) of interest exist when a CFP Board designee’s financial, business, property and/or personal interests, relationships or circumstances reasonably may impair his/her ability to offer objective advice, recommendations or services.”
In other words, the CFP board believes that an advisor’s personal interests can clash with the client’s and interfere with his ability to offer objective advice. Is this true? Not really.
The importance of context
There are no conflicts of interest among rational individuals. That’s because rational people take a long-term view of things and consider the impact of their decisions over the course of their entire life.
The context of human life is 70 years, 80 years, perhaps more. Pursuing your self-interest means pursuing what is necessary for life, your entire life. These needs include both physical needs (i.e. food and water) and psychological needs (i.e. happiness, which could include an endless number of material or spiritual values). In no case would a rational individual take actions that allegedly benefit him in the short-term at the expense of his life 20 or 30 years from now. In fact, any such short-term benefit isn’t really a benefit at all.
If an advisor values his business and his clients, then how do his personal interests clash with those of his clients? Answer: They don’t.
The vanishing conflict
One example frequently used to demonstrate a conflict of interest is the charging of commissions on products like life insurance or mutual funds. Because the advisor earns a commission on the sale of a product like life insurance, it’s said that the recommendation puts the advisor’s interests at odds with the client’s. After all, why wouldn’t the advisor seek out the highest commission at the expense of the client? He stands to make a lot of money from some of these products.
But why do rational advisors go into business? To make money. To build a client base. It’s not in their best interest to harm their clients. If they do, they’ll earn a bad reputation and eventually go out of business. Taking advantage of clients is career suicide. Just ask Bernie Madoff.
Does that mean that advisors should never sell highly commissionable whole life insurance? Universal life insurance? Variable life? No, not at all. Selling on commission poses no inherent harm to the client. It’s true that high-commissioned life insurance products often result in a lower cash value benefit for the client, but this isn’t always at odds with the client’s best interest. When a client does business with a financial advisor, and the client discloses the values he wishes to pursue, the advisor has to earn the client’s business by helping him achieve his values. This is really what matters most. If the client is able to successfully achieve his values, the advisor’s pay is irrelevant. If the advisor makes a lot of money in the process, good for him.
Moreover, just like in any other industry, the advisor has a moral right to seek the highest pay he can earn in his business, just as the client has a moral right to negotiate for the lowest possible fees and expenses by shopping around. When both the advisor and the client can agree on the terms of the business transaction, then both of their interests are served. The so-called “conflict of interest” vanishes, regardless of whether the adviser is paid by commission, fee and commission, or fee only.
