Wall Street Exposed – What You Must Know About Your Financial Advisor Now!

There is a simple but undeniable truth in the financial consulting and wealth planning industry that Wall Street has kept as a “dirty little secret” for years. That dirty little, and nearly always overlooked secret is THE WAY YOUR FINANCIAL ADVISOR IS PAID DIRECTLY AFFECTS THEIR FINANCIAL ADVICE TO YOU!

You want, and deserve (and consequently SHOULD EXPECT) unbiased financial advice in your best interests. But the fact is 99% of the general investing public has no idea how their financial advisor is compensated for the advice they provide. This is a tragic oversight, yet an all too common one. There are three basic compensation models for financial advisors – commissions based, fee-based, and fee-only.

Commission Based Financial Advisor – These advisors sell “loaded” or commission paying products like insurance, annuities, and loaded mutual funds. The commission your financial advisor is earning on your transaction may or may not be disclosed to you. I say “transaction” because that’s what commission based financial advisors do – they facilitate TRANSACTIONS. Once the transaction is over, you may be lucky to hear from them again because they’ve already earned the bulk of whatever commission they were going to earn.

Since these advisors are paid commissions which may or may not be disclosed, and the amounts may vary based on the insurance and investment products they sell, there is an inherent conflict of interest in the financial advice given to you and the commission these financial advisors earn. If their income is dependent on transactions and selling insurance and investment products, THEY HAVE A FINANCIAL INCENTIVE TO SELL YOU WHATEVER PAYS THEM THE HIGHEST COMMISSION! That’s not to say there aren’t some honest and ethical commission based advisors, but clearly this identifies a conflict of interest.

Fee Based Financial Advisor – Here’s the real “dirty little secret” Wall Street doesn’t want you to know about. Wall Street (meaning the firms and organizations involved in buying, selling, or managing assets, insurance and investments) has sufficiently blurred the lines between the three ways your financial advisor may be compensated that 99% of the investing public believes that hiring a Fee-Based Financial Advisor is directly correlated with “honest, ethical and unbiased” financial advice.

The truth is FEE-BASED MEANS NOTHING! Think about it (you’ll understand more when you learn the third type of compensation), all fee-BASED means is that your financial advisor can take fees AND commissions from selling insurance and investment products! So a “base” of their compensation may be tied to a percentage of the assets they manage on your behalf, then the “icing on the cake” is the commission income they can potentially earn by selling you commission driven investment and insurance products.

Neat little marketing trick right? Lead off with the word “Fee” so the general public thinks the compensation model is akin to the likes of attorney’s or accountants, then add the word “based” after it to cover their tails when these advisors sell you products for commissions!

FEE ONLY Financial Advisor – By far, the most appropriate and unbiased way to get financial advice is through a FEE-ONLY financial advisor. I stress the word “ONLY”, because a truly fee ONLY financial advisor CAN NOT, and WILL NOT accept commissions in any form. A Fee-ONLY financial advisor earns FEES in the form of hourly compensation, project financial planning, or a percentage of assets managed on your behalf.

All fees are in black and white, there are no hidden forms of compensation! Fee-Only financial advisors believe in FULL DISCLOSURE of any potential conflicts of interest in their compensation and the financial advice and guidance provided to you.

Understanding the conflict of interest in the financial advice given by commission based brokers enables you to clearly identify the conflict of interest for fee-based financial advisors also – they earn fees AND commissions! Hence – FEE-BASED MEANS NOTHING! There is only one true way to get the most unbiased, honest and ethical advice possible and that is through a financial advisor who believes in, and practices, full disclosure.

Commission and Fee-Based financial advisors typically don’t believe in or practice full-disclosure, because the sheer magnitude of the the fees the average investor/consumer pays would surely make them think twice.

Consider for a moment you need to buy a truck specifically for towing and hauling heavy loads. You go to the local Ford dealership and talk to a salesperson – that salesperson asks what type of vehicle you’re interested in and shows you their line of trucks. Of course, to that salesperson who earns a commission when you buy a truck – ONLY FORD has the right truck for you. It’s the best, it’s the only way to go, and if you don’t buy that truck from that salesperson you’re crazy!

The fact is Toyota makes great trucks, GM makes great trucks, Dodge makes great trucks. The Ford may or may not be the best truck for your needs, but the salesperson ONLY shows you the Ford, because that’s ALL the salesperson can sell you and make a commission from.

This is similar to a commission based financial advisor. If they sell annuities, they’ll show you annuities. If they sell mutual funds, all they’ll show you is commission paying mutual funds. If they sell life insurance, they’ll tell you life insurance is the solution to all of your financial problems. The fact is, when all you have is a hammer… everything looks like a nail!

Now consider for a moment you hired a car buying advisor and paid them a flat fee. That advisor is an expert and stays current on all of the new vehicles. That advisor’s only incentive is to find you the most appropriate truck for you, the one that hauls the most, tows the best, and is clearly the best option available. They earn a fee for their service, so they want you to be happy and refer your friends and family to them. They even have special arrangements worked out with all of the local car dealerships to get you the best price on the truck that’s right for you because they want to add value to your relationship with them.

The analogy of a “car buying advisor” is similar to a Fee-Only financial planner. Fee-Only financial advisor’s use the best available investments with the lowest possible cost. A Fee-Only financial advisor’s only incentive is to keep you happy, to earn your trust, to provide the best possible financial advice and guidance using the most appropriate investment tools and planning practices.

So on one hand you have a car salesperson who’s going to earn a commission (coincidentally the more you pay for the truck the more they earn!) to sell you one of the trucks off their lot. On the other hand, you have a trusted car buying advisor who shops all of the vehicles to find the most appropriate one for your specific needs, and then because of his relationships with all of the car dealers can also get you the best possible price on that vehicle. Which would you prefer?

Truly unbiased financial advice and guidance comes in the form of Fee-Only financial planning. You know exactly what you’re paying and what you’re getting in return for the compensation your Fee-Only financial advisor earns. Everything is in black and white, and there are no hidden agenda’s or conflicts of interest in the advice given to you by a true Fee-Only financial advisor!

The fact is unfortunately less than 1% of all financial advisor professionals are truly FEE-ONLY. The reason for this? There’s a clear and substantial disparity in a financial advisor’s income generated through commissions (or commissions and fees), and the income a financial advisor earns through the Fee-Only model:

Example #1 – You just changed employment and you’re rolling over a $250,000 401k into an IRA. The commission based advisor may sell you a variable annuity in your IRA (which is a very poor planning tactic in most cases and for many reasons) and earn a 5% (or many times more) commission ($12,500) and get an ongoing, or “trailer” commission of 1% (plus or minus) equal to $2,500 per year. The Fee-Only financial advisor may charge you a fee for retirement plan, an hourly fee, or a percentage of your portfolio to manage it. Let’s say in this case you pay a $500 retirement plan fee and 1.25% of assets managed (very common for a Fee-Only financial advisor in this situation). That advisor earns $500 plus $3,125 ($250,000 * 1.25%) or TOTAL COMPENSATION of $3,625 – FAR LESS THAN THE $15,000 THE COMMISSION (or Fee-Based) financial advisor earned! In fact it takes the Fee-Only financial advisor over four years to earn what the commission (or fee-based) advisor earned in one year!

Example #2 – You’re retired and managing a $750,000 nest egg which needs to provide you income for the rest of your life. A fee-based financial advisor may recommend putting $400,000 into an single premium immediate annuity to get you income and the other $350,000 into a fee-based managed mutual fund platform. The annuity may pay a commission of 4% or $16,000 and the fee-based managed mutual fund portfolio may cost 1.25% for total compensation of $20,375 first year (not including the “trailer” commissions). The Fee-Only advisor would possibly shop low load annuities for you, possibly put the entire portfolio into a managed account, possibly look at municipal bonds, or any other variety of options available. It’s hard to say how much the Fee-Only advisor would earn as their largest incentive is to keep you the client happy, and provide the best planning advice and guidance possible for your situation. BUT, in this case let’s just assume that a managed mutual fund portfolio was implemented with an averaged cost of 1% (very common for that level of assets), so the Fee-Only financial advisor earns roughly $7,500 per year and it takes that financial advisor THREE YEARS to earn what the fee-based financial advisor earned in ONE YEAR!

The prior examples are very common in today’s financial advisory industry. It’s unfortunate that such a disparity in income exists between the compensation models, or there would likely be many more truly independent and unbiased Fee-Only financial advisors today!

Now consider for a moment which financial advisor will work harder for you AFTER the initial consultations an planning? Which financial advisor must consistently earn your trust and add value to your financial and investment planning? It’s obvious the financial advisor with the most to lose is the Fee-Only advisor. A Fee-Only financial advisor has a direct loss of income on a regular basis from losing a client.

The commission or fee-based financial advisor however has little to lose. You can fire them after they’ve put you in their high commission products, and as you can see from the examples they’ve already made the majority of the commissions they’re going to make on you as a client. They have little to gain by continuing to add value to your financial and investment planning, and little to lose by losing you as a client.

Wouldn’t you prefer a financial advisory model where your financial advisor must continually earn your trust and add consistent value to your planning?

It’s clearly more difficult to earn a living and run a profitable financial advisory firm through the Fee-Only financial planning and guidance model. For this reason, most financial advisors take the easy way and sell products for commissions and charge fees on assets managed – that way they can make a nice living on your investment portfolio and still have an ongoing stream of revenue every year. For this reason also, less than 1% of financial advisors are truly Fee-Only, yet it’s that 1% that is truly objective and unbiased, and that 1% whose only incentive is to manage your financial plan, investments, and overall wealth to accomplish the goals you wish to achieve!

The real “dirty little secret” Wall St. has is the undeniable truth that the commission and fee-based financial advisory model has inherent conflicts of interest, and your advisor may be “selling you investment products” rather than “solving your financial problems”!

Greg Phelps is a CERTIFIED FINANCIAL PLANNER (TM) and Retirement Financial Advisor in Las Vegas and Henderson, Nevada focused on delivering clients exceptional financial advice and guidance on a Fee-Only basis. Greg has 14 years of financial advisory experience and is an accomplished advisor, author, and speaker. Greg has worked for two of the largest investment banking firms on Wall Street – Morgan Stanley and Goldman Sachs, as well as serving as the Regional Manager of Wealth Management at the 5th largest accounting firm in the country – RSM McGladrey.

The Regulation Of Financial Markets In The Southern African Region – Current Status And Developments

The success of the financial sector is a key component for economic development

The financial markets sector is one important area of public concern in Africa. The need for adequate regulation and supervision of Financial Markets as an important mechanism for the promotion of economic development in African countries cannot be overemphasized. Financial markets regulation remains a very sensitive and complex activity when it comes to governmental policy development, with relation to defining strategic options pertaining to financial regulation. This article reviews the current status of financial farkets, the legal and regulatory frameworks in the Southern African region, with a special focus on selected countries.

The topic under investigation relates to the regulation of financial markets by governments within the Southern African countries both at national and international levels. It attempts to grasp its rationale, objectives, approaches and the practical ways of defining a regulatory framework for a modern African financial market and system. At a time many experts are calling for liberalization of financial services in Africa, it is important to analyze what are the rationale, advantages and implications of financial markets regulation for Southern African countries under the light of new international instruments and standards, such as the Basle II Framework and the WTO Agreement on Financial Services of 1994, whose operational modalities are is still under negotiations on various key aspects.

This paper attempts to examine the institutional and regulatory framework for the financial markets operations in order to understand the underlying principles of financial markets regulation development; to develop a concise outline of financial markets regulation framework within the South African countries; and provide as much as possible a clear understanding of policy development, key issues and challenges relating to the regulation of financial markets in the Southern African region.
The terminology used in the financial markets jargon is considered to be highly technical and can some times be confusing. While we attempt to keep a non technical language through out this paper, it is quite impossible to avoid the specific concepts used in the financial profession. For some key concepts, a concise glossary of most of the technical words is provided at request by the author.

The Southern African region: geographic coverage and scope

The broad Southern African Region considered under the present study is defined with reference to the SADC membership, currently comprising 14 countries, i.e. Angola, Botswana, Congo (the Democratic Republic of), Lesotho, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe. However, our scope is limited by the criteria of readily available data, and the level of financial markets development in the countries under investigation. Angola and the Democratic Republic of Congo are emerging from long wars and are still rebuilding their economies and financial systems. Both have no formal financial market. Accurate and reliable data is very limited on their systems. The study covers a period of 10 years (1994-2004).

Background overview on Financial Markets

The regulation of Financial Markets, taken as a broad concept, is the process that encompasses regulation, (i.e. the establishment of specific rules of behaviour), the monitoring (i.e. observing whether the rules are respected) , the supervision (a more general observation of the behaviour of financial institutions and operators), and the enforcement (ensuring that the rules are complied with) of the established laws.

The ultimate economic function of financial markets is to mobilize and allocate resources through financial intermediation in order to accelerate the process of economic growth. This function is performed through two distinct but interrelated components of the financial markets, i.e. the money market and the capital market. It provides channels for transferring the excess funds of surplus units to deficits ones. They constitute the mechanism that link surplus and deficit units, attracting funds from savers in the surplus sector and channeling these to borrowers for the purposes of profitable investment.

For the purpose of providing a clear understanding of this topic, it is profitable to present a wide overview of a typical financial system and the place of the financial markets holds within this framework. As a practical illustration, we provide in a table of Annex I, the Conceptual Framework of a typical financial market system (the Case of South Africa).

Financial Systems and Financial Markets development

The financial system in the Southern African region consists of providers and users of financial services. The typical financial system consists of a variety of institutions, instruments and markets that facilitate the flow of financial resources between borrowers and lenders. The financial institutions include moneylenders, banks, insurance companies, leasing companies, venture capital funds, mutual funds and pension funds, brokerage houses, investment trusts and stock exchanges.

Financial instruments involved range from currency notes and coins, cheques, mortgages, corporate bills, bonds and stocks to futures, swaps and other complex derivatives. The markets for these instruments may be organized or may be informal. The users of the markets may be households, businesses and the government. Compared to those of developed countries (Europe, Asia and America), the typical financial markets in the Southern African region are characterized by the absence or a limited number and quality of the financial services providers, the absence of many of the instruments and the lack of depth in the markets.

Financial Markets typology and structure

The financial markets play a very important part in the economy of a country and the well-being of every person. They interact with other markets and have an influence on issues such as wealth, inflation and economic stability in a country. The financial markets have their own characteristics and to be able to regulate them or operate in them, it is important to comprehend these characteristics.

Classification of Financial Markets

Financial Markets can be classified into different categories depending on the characteristic of the market or instrument used to create categories. There exist two ultimate distinctions of financial markets. The primary market, i.e. for the sale of new markets, and the secondary market for already existing securities. The capital market, which is the market for the issue and trade of long-term securities, on one hand and the money market, i.e. the one of short-term securities, on the other hand,
In general terms, the money market is the market where liquid and short-term borrowing and lending take place. The lending of funds in this market constitutes short-term investments. In a certain sense all bank notes, current accounts, cheque accounts, etc. belong to the money market.
In financial market terms, the money market exists for the purpose of issuing and trading of short-term instruments, that is, instruments where the term remaining from the date when trading takes place to the date of redemption of the loan represented by die instrument (commonly referred to as the “term to maturity”), is of a short-term nature. In theory, this term for classification as a money market instrument is given as one year. In practice, however (especially in South Africa), instruments with a term to maturity of three years or less are normally classified as money market instruments although this is not a hard and fast rule.
For the purpose of regulation, the classical typology of Financial Markets recognizes the following major distinctions :

  • the inter-bank and credit markets
  • the Money Market ;
  • the Equity Market ;
  • the Foreign Exchange Market ;
  • the Bond Market (for Government bonds, Corporate bonds, Eurobond market, structured bonds, etc.) ;
  • the Derivatives Market: ( for Futures, Swaps and Options)

Apart from the above mentioned categories, an other important distinction is established between the domestic financial markets and the international financial markets.

The institutional framework for the regulation of Financial Markets.

A financial system cannot be effective without an adequate regulatory framework. For a financial system to be effective and promote healthy economic development, it is important to put in place a sound legal and institutional framework. Various strategies and approaches are generally considered by experts for the development of financial systems. Two major strategies commonly considered are the “evolutionary” and the “proactive” approaches. Other experts have made a distinction between the “go slow” versus the “big bang” approach.
The pro-active strategy provides legal, regulatory and prudential framework which accelerates financial market development through mechanisms, institutions and financial instruments set up for this purpose. This strategy is considered as the appropriate approach for African and other developing countries for three main reasons:

  • Inadequate neutral incentive environment and market forces that are insufficiently strong for financial markets to develop by themselves.
  • Lack of institution-building capacity to determine the pace and strength of financial markets development.
  • Need for flexibility to allow for the use of the most efficient institutional set-up, required training infrastructure and choice of technology that is most suited to the local conditions and level of development.

The Rationale, Principles and Objectives of Financial Markets Regulation1. The necessity for a Financial Market Regulation

      Why regulate Financial markets? This question is central to the subject under investigation in this paper and before we attempt to grasp the rationale and objectives of financial markets regulation, it is important to understand why such regulation should exist in the first place. The necessity for a financial market regulation finds its basis in the same principles applied to the financial sector in general. Borrowing and lending of money create certain risks, namely :

      • That the borrower will not be able to repay the money ;
      • That the lender is receiving a fixed rate on his investment while market rates fluctuate in such a way that the yield on his initial investment is now below current market related rates ;
      • That the value of the capital invested could decrease due to movements in the market. In order to clearly define the rights and obligations of investors, borrowers, operators and intermediaries involved in a financial system and who operate under contractual relationship, it is of the highest importance to develop a cohesive and comprehensive legal and regulatory framework.

The stakes involved in the running of a country’s financial markets are very high and it would be deeply irresponsible to apply the rule of “laisser-faire” in this very sensitive sector. In case some thing would go wrong or the financial system could undergo a serious crisis, it would result into a total collapse of the entire economy.

Such a framework should encourage discipline and timely enforcement of contracts, fostering responsibilities and prudent behaviour on both sides of the financial transaction. For a country’s market to develop and operate efficiently, the legislative and regulatory framework should incorporate rules on trading, intermediation, information disclosure as well as strict sanctions against defaulters and cheaters.

2. The Rationale of Financial Markets Regulation

    The rationale underlying the financial market regulation is the general philosophy and ideological background pertaining to a specific country’s economic orientation, and the type of economic system adopted by the country’s leadership. At present, most of the countries covered by the study are characterized by a “market oriented ” economy. However, some of these countries have been under a centrally planned economy until the 1990s when they dramatically changed their economic orientation. It is the case of Tanzania, Mozambique and Angola. The changes were particularly due to persistent deficits in public budget and their inability to support the considerable burden of state owned companies unable to achieve the target economic performance. This new orientation facilitated the development of more diversified and active financial systems, leading to the creation of Financial markets in Tanzania and Mozambique. Financial Markets have their own unique characteristics and financial operators differ from one country to an other. The financial market framework should facilitate rather than impede the efficient operation of the financial system.

The Principles of RegulationIn theory, there is a distinction between general and specific principles. The following general principles are widely recognized for the formulation of an effective regulatory process:

  • Every regulatory arrangement should be related explicitly to one or more objectives identified;
  • All regulatory arrangements should be justified with respect to their cost-efficiency;
  • The cost of regulatory arrangements should be distributed equitably ;
  • All regulatory arrangements should be sufficiently flexible, in the sense of being amenable to changes in markets, competition and the evolution of the financial system ;
  • Regulatory arrangements should be practitioners- based.

Specific principles are identified as follows:

      a. Principles related to the regulatory structure:

        What is the adequate structure for financial markets regulation. One major issue in Financial markets regulation relates to the number of regulatory and supervisory agencies involved. The issue of the choice between a single regulatory authority or multiple specialized agencies is generally resolved according to the following principles:

        • there is a need to adopt a “functional” as well as an “institutional” approach ;
        • the coordination of regulation by different authorities and agencies will help to achieve consistency ;
        • there should be a presumption in favour of a limited number of regulatory agencies /authorities.

In practice, the institutional and functional approaches need to be employed in parallel because regulatory authorities are concerned with the soundness of institutions, as well as the way in which services are provided.

b. Principles related to the market efficiency :

        These are principles designed to contribute to the promotion of a high level of efficiency in the provision of financial services. They are :

          (a) the promotion of a maximum level of competition among market participants in the financial system, and (b) the securing of competitive neutrality between actual or potential suppliers of financial services. Competitiveness is likely to enhance market efficiency, which in turn causes the removal of restrictive practices that could impair trading in financial assets and the rationalization of market activity.

c. Principles related to market stability :

        These principles are expected to contribute to the promotion of a high measure of stability in the financial system and an appropriate degree of safety and soundness in the financial institutions. There should be incentives for proper assessment and management of risk. It is necessary to impose acceptable minimum prudential standards to be observed in respect of risk management by all financial market participants.

d. Principles related to conflict conciliation :

      Conflict conciliatory principles are designed to resolve potential conflicts arising between regulatory principles themselves. They would involve an integrated approach, aiming at the simultaneous achievement of regulatory objectives, and a target-instrument procedure for the selection of key regulatory instruments in order to facilitate the implementation of an integrated approach.

The Objectives of Financial Markets RegulationFor a Financial Markets system to perform to its highest capacity and level, regulation need to be both effective (i.e. to achieve its objectives) and efficient (i.e. to be cost effective in the use of its resources).

The economic dimension of a financial markets system requires that regulation should not impose unwarranted costs on the economy and consumers, nor impair the efficiency of financial markets. It is therefore necessary to consider a cost-benefits analysis exercise to assess the regulatory requirements.

The more complex a financial market is and more business operators increase, the regulatory process becomes more demanding and requires more specific objectives. Efficient financial regulation requires a multi-dimensional approach and a more optimizing process.

1. The overall objective of financial markets regulation:

    The ultimate objective of financial markets regulation is to achieve the highest degree of economic efficiency and the best consumer protection in the economy.

2. Specific objectives:

      The following Specific objectives can also be highlighted:

      • to secure the stability of the financial system.
          It is important for a country’s economy to run smoothly and the financial sector must be protected against internal or external shocks which might be caused for instance by ineffective or inefficient trading clearing and settlement systems or a major lack of market liquidity ;
      • to ensure institutional safety and soundness.
          The regulatory framework should be extremely cautious and avoid to impose obstacles or barriers that would impair the safety and soundness of financial institutions, which need to be profitable and have sufficient capital to cover their risk exposure and face global competition ;
      • to promote consumers’ protection:
          It is crucial for a financial market to impose integrity, transparency and disclosure practices in the supply of financial services.

Concluding RemarksIn all Southern African countries, as it is in all countries of the world, the financial system is more regulated than any other industry. On the consumer protection grounds and others highlighted in this study, it is universally accepted that this should be so. Existing empirical evidence suggests that regulatory arrangements have a powerful impact on the size, structure and efficiency of financial systems, the business operations of financial institutions and markets, and on competitive conditions in the systems.

The success of a financial markets regulation depends basically on the capacity of the regulators to define the objectives of the regulation and also on the way the regulatory arrangements are related to their objectives.

Some of the countries in the Southern African Region which were able to promote a dynamic and effective regulatory framework, such as Botswana, Namibia, Mauritius, Zambia, Zimbabwe and in particular South Africa, are benefiting from the positive development of financial markets, with an unprecedented flow of capital from foreign investors.

However the financial systems in the region are still limited, in terms of the number of operators, quantity and quality of instruments and the depth of the systems. And there is still need to develop regulatory institutions, structures and mechanisms that can maximize the explicit objectives of regulation while minimizing the costs of services.

The author, is an International Consultant on Trade and Investment, Director of InterConsult Mozambique and is the Representative of Emerging Market Focus (Pty) in Mozambique. This insight paper is aimed at advising investors and business people involved in international trade by providing them with accurate legal data on the institutional and legal framework of Mozambique and the Southern African region.


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