Your Financial Advisor's Conflicts of Interest

Conflict of interest in finance can arise when a financial advisor’s personal incentives are not aligned with the best interests of their clients. Financial advisors may face pressure to recommend products that provide them with higher commissions or that benefit their employer, even if those products are not ideal for their clients’ financial goals. Such conflicts can subtly affect the advice clients receive, often resulting in higher costs or less optimal financial outcomes. Understanding the various types of conflicts of interest, as well as how they might manifest, can help individuals make more informed decisions when working with financial professionals.

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Conflicts of Interest for Financial Advisors

Conflicts of interest generally arise when the financial goals or interests between advisors and clients don’t align. In many advisory relationships, financial professionals sit down with clients to identify investment objectives, risk tolerances and time horizons. Clients can also specify any investment limitations or restrictions, but advisors generally hold the discretionary authority to make financial decisions on behalf of each client.

But how do you find an advisor’s conflicts of interest? A more DIY-based approach is to review the financial advisor firm’s Form ADV. A Form ADV is paperwork that all advisory firms registered with the U.S. Securities and Exchange Commission (SEC) must complete. The paperwork has two parts. Part I outlines each firm’s client base, assets under management (AUM), office locations, fees and disclosures.

Part II contains a firm brochure that the firm itself writes. The brochure essentially outlines the advisor’s investment strategies, advisory services, industry affiliations, fee schedules and conflicts of interest. Fortunately, both parts are publicly available. You’ll be able to use this to your advantage if you’re working with an affiliated advisor of an SEC-registered firm.

What Are Some Common Conflicts of Interest?

These are common financial advisor conflicts of interest.

Advisory firms with fee-based fee structures often have affiliations with registered broker-dealers and/or insurance agencies. This allows firm representatives to earn commission-based compensation from selling insurance or investment products, creating a conflict of interest because advisors have a financial incentive to recommend certain securities or products over others. It’s important to note that this form of compensation is in addition to asset-based fees.

Performance-based fees can also create a conflict of interest if the advisor participates in side-by-side management of performance fee accounts and asset-based fee accounts. When it comes to investment opportunities, advisors may become incentivized to favor accounts with higher fees over other asset-based accounts with lower fees. Fiduciaries often disclose such conflicts of interest, regardless of their fee structure.

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Fee-Only vs. Fee-Based: What’s the Difference?

Fee structure is often a reliable indicator of whether your advisor will have any conflicting advisory practices. The two most common fee structures are fee-only and fee-based. If your advisor has a fee-only fee structure, they’re compensated solely for the advisory services they provide and not for the investment products or money managers they sell or recommend. This also means that they don’t earn commissions.

In providing financial services, fee-only advisors may earn compensation through a percentage of client assets. These advisors also charge flat fees and/or hourly fees. Fee-based advisors typically earn commissions in addition to the asset-based fees collected from clients. As mentioned earlier, these commissions generally come from insurance or investment products.

Fiduciary vs. Non-Fiduciary Advisors

A fiduciary standard is a legal obligation that requires financial advisors or advisory firms to work in each client’s best interest. All SEC-registered investment advisors and advisory firms have a fiduciary obligation, regardless of fee structure. In honoring the legal standard, advisorsfdf must disclose any conflicts of interest. Non-fiduciaries usually operate under a different standard.

Examples of non-fiduciaries include, but aren’t limited to, broker-dealers and broker-dealer firms and insurance agents. These advisors are typically registered with the Financial Regulatory Insurance Authority (FINRA) or state insurance regulators.

Whereas fiduciaries must honor a fiduciary standard, non-fiduciary broker-dealers historically have been required to abide by a “suitability” standard. Unlike the fiduciary standard, the suitability standard only requires financial professionals to provide advice that is most suitable to a client’s needs.

However, these finance professionals are now required to adhere to Regulation Best Interest (Reg BI), which was designed to increase accountability and protect consumer interests. Under this regulation, broker-dealers must make recommendations in their clients’ best interests, although it’s not quite as stringent as fiduciary duty.

Getting a Second Opinion

If you suspect a conflict of interest with your financial advisor, getting a second opinion can be a practical next step. Seeking advice from a fee-only advisor can help you determine whether the recommendations you’re receiving are in your best interest. Some advisors offer standalone services, including one-time checkups or free consultations. .

Comparing different viewpoints not only provides clarity but also ensures that the financial strategies align more closely with your objectives rather than an advisor’s potential personal incentives. Ultimately, having multiple perspectives empowers you to make a more informed decision about your financial plan.

Questions to Ask Your Advisor to Uncover Conflicts of Interest

Reviewing Form ADV and checking FINRA BrokerCheck are essential steps, but the conversation you have with a prospective advisor before signing anything can be just as revealing. How an advisor responds to direct questions about compensation and conflicts tells you as much as the answers themselves.

How are you compensated for the recommendations you make?

This is the most fundamental question and the one advisors are most accustomed to answering. What you are listening for is specificity. A clear explanation of whether they earn fees, commissions or both, and under what circumstances each applies, is a reasonable expectation. Vague or evasive answers to a straightforward question are worth noting.

Do you or your firm receive any compensation from third parties related to the products you recommend?

Some advisors receive revenue sharing arrangements, referral fees or other payments from fund companies, insurance carriers or money managers whose products they recommend. These arrangements may be disclosed somewhere in the Form ADV but are not always volunteered in conversation. Asking directly puts the obligation on the advisor to confirm or deny.

Are you affiliated with a broker-dealer or insurance company, and does that affiliation create any incentive to recommend certain products?

Fee-based advisors who are also registered as broker-dealer representatives may have production requirements or preferred product lists that influence what they recommend. This question surfaces whether the advisory relationship exists alongside a sales relationship, and how the advisor thinks about managing that tension.

Do you have any revenue minimums, sales quotas or production targets that could influence your recommendations?

Some advisors working within larger firms face internal pressure to meet sales benchmarks. This question is less commonly asked and may catch an advisor off guard, but the answer provides useful context for understanding whether recommendations are driven purely by your financial situation or partly by internal firm dynamics.

Have any of your clients ever filed a complaint against you, and if so, what was the nature of it?

This question is not intended to disqualify an advisor for having any complaint on record. Its purpose is to see whether the advisor is forthcoming about their history and how they describe situations where a client was dissatisfied. An advisor who is transparent and takes responsibility for past issues is more trustworthy than one who dismisses or deflects.

How do you handle situations where a product that pays you a higher commission is also a reasonable fit for my situation?

This question tests whether the advisor has thought seriously about how they manage conflicts rather than simply whether conflicts exist. A thoughtful answer that explains their process for choosing between comparable options is a positive sign. An answer that denies the scenario ever arises is less reassuring.

Are you a fiduciary at all times, or only when providing certain types of advice?

Some advisors are fiduciaries in their capacity as investment advisors but operate under the lower Regulation Best Interest standard when acting as broker-dealers. Asking specifically whether the fiduciary obligation applies to every part of your relationship, including insurance recommendations and product sales, clarifies the scope of their legal obligation to act in your interest.

Bottom Line

With the assistance of a financial professional, you can significantly grow your wealth over time. But you’ll want to take note of factors such as the firm or advisor’s compensation structure and/or any potential conflicts of interest. Financial firms and advisors with fee-only fee structures generally have a lower potential for conflicts of interest than fee-based advisors do. This is mainly because fee-only advisors don’t earn additional compensation from other products.

In narrowing down your search, remember to determine whether your advisor honors fiduciary duty or Regulation Best Interest. Keep in mind that fiduciaries typically must adhere to a higher standard. When it comes to investing, retirement planning or financial planning, a fiduciary may be the better choice. Even if your advisor has conflicts of interest, their fiduciary obligation will protect your assets over the long term.

Tips for Finding a Financial Advisor

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Do you need help managing your investments or have more specific needs, like estate planning and tax strategy assistance? Before choosing an advisor, assess your personal needs and focus your search for an advisor on those who specifically offer the services that align with these needs. As you examine your own financial situation, think about your risk tolerance, short- and long-term goals, as well as your time horizon – how long you have before reaching these goals.