It is hard to avoid. At some point, you need to work with a banker, broker, agent or realtor to obtain the financial products that can help make you wealthier. The Fed’s Survey of Consumer Finances showed that nearly 40 percent of families will consult a banker or a broker for financial and investment advice. Aside from friends and family, financial agents are the second or third most common source of financial information.
Advice from a financial professional is often free, but that doesn’t mean there isn’t a catch. Most financial representatives earn a commission based on how much they sell you. Sometimes this is a good incentive. Sometimes it gives financial professionals an impetus to sell instead of give unbiased advice. In any case, it’s a good idea to know how financial professionals are getting paid before you sit down and discuss your financial needs.
Stock brokers can earn a commission by every trade you make (every time you buy or sell), by a percentage of the gross value of your assets or a combination of both. By earning a percentage of your portfolio value a broker has an incentive to see your investments grow. However, it also gives the stock broker an incentive to advise you to hold your money in financial assets longer than you may want or need. Brokers that are paid by making trades have a tendency to constantly sell new investment opportunities to get you to make trades. This is not always in your best interest and may be nothing more than an attempt by your broker to earn a bigger paycheck.
It’s a good week for an insurance agent when you purchase some piece of mind from them. Agents are paid a percentage of the premiums paid for a purchased policy. Each year that you renew a policy, agents receive a percentage of that year’s premium payment. Usually the percentage earned on a new policy is greater than a renewed policy. The payment structure gives an insurance salesman an incentive to sell you a bigger policy than you need and to keep you paying for that policy longer than necessary.
When you walk into a bank branch, sit down and open an account or take out a loan, the guy behind the desk is earning a cut. Generally, bankers earn a base salary and a commission on the product that they sell you. By cutting back on commissions paid, bankers have less of an incentive to sell you bigger loans than you need, especially since underwriters will often deny unworthy credit applicants. However, there is an incentive to sell you multiple financial products.
When I was first married and went to the bank to add my wife to my account, the banker wanted ‘me to open a new joint account. Why? There is no commission paid to simply add my wife’s name to an existing account. While this example is fairly harmless, there are other product bundles that can be detrimental to your finances. When shopping for a mortgage, a banker tried to sell me on a piggy-back home equity lending scheme so I could do a no down-payment home purchase even though I had money for a down payment. Clearly, the banker would have benefited most by this arrangement and I would have paid much more interest to the bank for borrowing.
Realtors are paid strictly on a percent of the final selling price of a home. Usually, the percentage is six percent and is split between the buying and selling agents. This works to a seller’s advantage since a realtor earns more money with a higher selling price. However, it also means that realtors representing buyers have an incentive to show more expensive houses to their client. There is also an impetus for any realtor to settle quickly and earn their commission on as little work as is possible.
It’s not a bad idea to work with financial agents. For some products, you have no choice but to work with them. However, you should be aware of where there are conflicts between giving you the best representation and their incentive to collect a paycheck.