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Financial Advisors Constantly Facing Ethical Issues
The daily news is chock full of major financial blunders by giant corporations, and these headline-grabbing issues provide constant reminders of how our modern maze of business models, methods of practice and investment strategies have substantially blurred traditional ethical boundaries.
Even scrupulously honest financial planners can now face real dilemmas when trying to do the right thing for their clients.
"Independent Financial Advisors are constantly playing a tug of war when it comes to doing what's right," said Chris Hastings, CEO of Sapphire Software Services, which developed Panoramix, the popular at-a-glance portfolio management dashboard for IFAs. "Clients want results, and advisors must take into careful consideration the ethical boundaries.
Here are some common dilemmas investment professionals face, and some guidance on how to respond to them:
Commissions vs. Fees?
Regardless of what legal or moral standard they are held to, one of the biggest ethical dilemmas planners face is choosing a method of compensation. The methods of compensation for both sales-driven practitioners and planners are often interchangeable, since each can charge either fees or commissions for their services (provided that they are licensed to do so). However, this flexibility can often present a moral dilemma for planners who must choose one method of compensation over the other.
A fee-based planner, one who charges clients based on a percentage of their assets, will increase his or her compensation simply by making the client's assets grow. If the planner charges the client a fee of 1% of assets under management, then the annual fee collected from a $500,000 portfolio will be $5,000.
Therefore, if the planner is able to make the portfolio grow to $150,000, his or her compensation will increase accordingly. This type of compensation could motivate the planner to employ more aggressive investment strategies than a traditional commission-based broker.
A commission-based planner, on the other hand, is compensated for each transaction, regardless of portfolio gains or losses. These brokers face the temptation to generate transactions as a means of revenue, even if they manage to avoid the technical definition of "churning."
In this sense, each type of compensation presents its own set of ethical issues. Ultimately, planners will have to be willing to subordinate their own benefit to that of their clients, regardless of what business model is used.
The key to remember is that you must act in the best interests of your client, not your wallet.
Advice vs. Sales?
The boundaries between sales and advice in the financial industry are also becoming increasingly blurred as new platforms and methods of doing business continue to emerge. What this usually boils down to is getting clients to do the right thing for the right reason.
Many clients will base their financial decisions on emotions rather than what their planner advises. Suppose a 60-year-old woman has her entire savings of $100,000 in certificates of deposit (CDs), and is terrified of risking her principal. If she lives for another 25 years, her savings will likely be depleted long before she dies, since these low-risk investments pay a tiny rate of return that will be offset by inflation over time.
As a planner, you obviously need to get your client to diversify her holdings with a sensible asset allocation, or perhaps at least consider some sort of immediate annuity option. But how far should you go in encouraging her to do this? Is it OK for you to use aggressive, fear-based sales tactics, or even bend the truth a little, in order to help this client? After all, it clearly is in her best interest to do this.
Besides, if no action is taken, you could be held legally liable for failure to provide adequate advice. In this case, the definition of "fear-based" sales tactics is also somewhat subjective; if the planner shows the client a graphic illustration revealing how she will be bankrupt in less than 10 years, is that using fear as a tactic, or is it merely a revelation of reality?
The argument can be made that it is both at once.
Luckily, planners do have help in these types of situations. If a client refuses to take your advice, you can present your client with a written disclaimer that states the client or prospect is refusing to follow the recommendations presented by the planner. And if your 60-year-old client wants her CDs and she's signed this disclaimer, then you are in the clear.
Long Story Short?
Today, financial planning depends more than ever upon understanding a client's individual situation and objectives, and being willing to do the right thing for them. The correct application of ethics in modern financial planning essentially boils down to having the client understand exactly what they are doing and why, with full knowledge of the costs and risks involved.
An ethical transaction occurs when a client truly understands the ramifications of the advisor's recommendations and is willing to go forward, assuming that all pertinent laws and regulations are being obeyed. After all is said and done, ethics can still be viewed as simply knowing the right thing to do, and then doing it.
"Do what's right and success will come," adds Hastings. "It never fails."
Panoramix™ was developed by Sapphire Software Services, a custom software and business-to-business automation company founded in 2003. Sapphire brings business applications to the web, provides consulting services with the best vendors and partnerships, and offers professional development capabilities to automate business processes. Sapphire specializes in business application software development for companies in the financial services sector. For more information on Panoramix, or to schedule a live demo of the product, contact Panoramix at email@example.com. Also, go to www.panoramixfinancial.com to view an on-demand demo of Panoramix.
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