Dealing with financial advisors is typically a necessary part of getting involved in the financial markets. If you are going to invest, you will most likely have to work with a financial advisor at some point. Financial advisors sometimes experience conflicts of interest that they have to deal with. Here are a few things to consider about financial advisors and conflicts of interest.
Conflict of Interest
A conflict of interest takes place when a financial advisor is not thinking about only what is best for their clients. When this occurs, some outside influence is affecting their judgment. In many cases, this can negatively impact the investors because the advisor is not thinking about their investment goals during this time period. Here are a few situations where a conflict of interest might come up with your advisor.
Investment Banking Relationships
Sometimes, an investment banking relationship could cloud the judgment of your financial advisor. Investment bankers are utilized whenever a stock or some other security is listed on stock exchanges. In order to generate interest for the stock or other security, investment bankers will work with financial advisors that they are familiar with. The investment banker will talk to the advisor about offering this security to the advisor's clients. The advisor will then take the security to their clients and convince them to invest money in it. The advisor may not actually know that much about this new stock, but they still push it on their clients anyway because of their previous relationship with the investment banker. Sometimes the investment will work out well for everyone. Other times, this could be a disastrous investment for the advisor's clients. When this happens, the relationship between the advisor and the investment banker negatively affects the clients.
Something else that tends to create a conflict of interest is commissions that are paid to the advisors. Financial advisors typically receive a majority of their compensation from commissions. They receive commission when one of their clients purchases a particular security. For example, if a client buys shares of a mutual fund, the introducing broker is going to receive a certain amount of that sale. This is generally an accepted fact in the investment world. However, this creates a scenario in which many investment advisors will seek out the products that pay the greatest commission. Instead of focusing on what investment is going to be best for the client, they want only to generate a large commission for themselves. When you are working with a financial advisor, it is important to determine if she is recommending an investment only because of the commission or if she really has your best interests in mind.
Many people choose to work with a financial advisor that is a family member or friend. While this might seem like a logical choice at first, it can lead to conflicts of interest. Many times, it is best to keep your personal and financial lives separate. You do not always want a family member or friend to know everything about your investments.