Why don’t financial services professionals (i.e., planners and advisors) ever recommend alternative assets like private placements for their clients?
Because they’d go hungry. I’ll explain why below…
First, in this article, when I refer to financial advisors, I’m also referring to financial planners for purposes of discussion of their compensation structure and motivations.
So why wouldn’t a financial advisor ever recommend private placements to their clients? It’s because:
- Most financial planners are financially illiterate.
- They have no clue as to what assets to add to your portfolio that would be in your best financial interest.
- There’s no money in it for them.
You may think I’m being a little harsh on the financial services industry, but I’ll let a former financial advisor explain what the industry doesn’t want you to know in his own words.
In a December 2015 Forbes Article titled Confessions Of A Former Financial Advisor: 5 Things I Didn’t Tell My Clients, former financial advisor, Erik Carter listed the 5 dirty little secrets financial advisors didn’t want their clients to know.
The secrets followed by my commentary are as follows:
My main qualification for my first investment job out of college was selling knives. Sales – not financial literacy – is the main qualification for securing a position with a financial services firm. This is related to item #2 below.
I was only paid to sell certain products or gather assets. Most financial advisors make money from commissions and fees from selling financial products, executing stock buy/sale orders, and in the case of IRA custodians, convincing clients to open IRA accounts and rolling assets into them (i.e., gathering assets).
Common financial products advisors can earn significant compensation from are:
- Public Investments.
- Insurance Products
- Loans.
Their commissions are paid by kickbacks from mutual funds, insurance companies, and financial institutions for selling their products. Private placements and other alternative investments are not high on the list of commission-paying investment products/assets.
I couldn’t reliably beat the market. He’s not alone. When taking into account fees and commissions, 92% of professional fund managers – supposedly the best of the best in the financial services world – fail to beat the market.
In other words, you’re better off putting your money in an index fund than entrusting your money with a financial professional.
I didn’t help the people who needed it the most. The people who need wise financial advice the most are the people punching a clock looking to get out of the rat race. It’s not the millionaire who has already made money from a business or inheritance.
For building wealth and obtaining true financial independence, the financial advisor is the wrong person for the job. His financial motivations are in direct conflict with those of his clients.
I may even have enabled clients to hurt themselves. This should have been #1. Erik Carter left the financial advisory profession because he knew that people who invested through financial advisors were only making the advisors rich and not the other way around.
Commissions, fees, and the unpredictability and volatility of the markets prevented investors from achieving financial independence.
An article on the Motley Fool focused on the practices at the investment firm Edward Jones backs up Mr. Carter’s revelations above.
Here’s what the article had to say:
Edward Jones not only uses a burn and churn business model for generating commissions from stock transactions but this model also applies to their hiring practices.
This is reflected in the company’s high turnover in its advisor ranks. This isn’t surprising since the main qualification for advising is being able to sell. In this case, one advisor could easily step into the shoes of another advisor without skipping a beat.
Backing up Mr. Carter’s confession of failing to beat the market, the Edward Jones article revealed that most advisors were unqualified to make investment recommendations. Ultimately, the authors behind the article found that the firm’s very business model – which is representative of broker-dealers as a whole – is structured in favor of revenue generation, at the expense of providing the best possible investment advice for its clients.
Brokerage firms often have sweetheart deals with particular funds, insurance companies, and financial institutions that private companies can’t compete with.
In most cases, most advisors are prohibited by firm policies from even recommending private placements.
The 5 dirty little secrets revealed above explain a lot about why financial advisors would never recommend private placements to their clients, but there are other reasons why this might be the case including the following:
FIRST. Financial Advisors lose the ability to churn. Private placements are illiquid with typical lockup periods of a minimum of 5 years+. Illiquid investments kneecap an advisor’s ability to churn the invested capital for commissions.
Imagine a financial advisor recommending a $200,000 commitment to a private placement with a seven-year lockup period. They would make a commission when the funds are first invested and possibly when the fund winds up. Contrast that with the average $8 to $10 per trade commissions stretched out over thousands of trades per year.
Why would any advisor give up this cash cow?
SECOND. Attrition. It’s hard to beat the ROI from private investments. If most advisors can’t beat the market average annual return of 5.9% (20-year average annual S&P 500 return), what do clients have to gain from investing through an advisor?
With private funds offering annual preferred returns of 6%+ plus a percentage of profits for annualized returns of 10%+, why would an advisor ever introduce clients to this alternative world and kill their golden goose?
THIRD: They lose influence. I’ve spoken to more than a few advisors who admit that they do not like the influence that private placement managers wield as experts in their fields with documented track records.
The advisors lose clout since many of these managers make themselves available to potential investors to ask them questions and pick their brains.
So why wouldn’t a financial advisor recommend private placements?
Because it would expose them as the snake oil salesmen that they are and once these clients gain exposure to this private investing universe, they’ll conclude very quickly that they don’t need a financial advisor to achieve their financial goals. They actually may be a hindrance.
Why would a financial advisor kill the golden goose of transaction-based commissions and fees? They wouldn’t. That’s why they don’t recommend private placements or any other alternative investment.
