I’ve been thinking about business models and remuneration structures recently.
I’ve been thinking about financial advice and how it could be provided with as few conflicts of interest and as little bias as possible.
This thought experiment has reinforced my view that no one can say they are unbiased or free of conflicts of interest.
We all have biases. At a personal level, I am biased towards my own self-interest and the interests of my wife and children. When it comes to building wealth, some of my biases are towards diversification, paying lower fees than necessary, and not having “bad debt” (eg for depreciating assets, such as for cars). As a psychological level, I share the biases that are universal across the human race: I’m more sensitive to losses than gains; I’m sensitive to the representative bias; my memory is fallible.
I’m biased because I’m human. I try to “choose my illusions” in the sense that I try to train myself to be biased towards things that are useful and true. But I can’t say that I’m perfect and nobody can.
We all have conflicts of interest. I’ve mentioned my bias towards my own self-interest and those of my family. If I’m working, I’d rather get the same outcome for less effort, time, resources, and risk.
In the world of commerce, remuneration structures introduce a host of conflicts. Not a single remuneration structure is conflict-free.
- With commission, the conflict is clear. The adviser/salesperson is incentivised to get a sale. They are incentivised to get more and bigger sales. With other forms of remuneration, the conflicts are less apparent but still very real.
- Most investment advisers charge fees as a percentage of funds under advice (asset-based fees). (Some people wonder whether this is distinguishable from commission. It is – because ultimately, it’s the client paying the fee, not the product issuer.) This creates an incentive for increasing funds under advice, which might sound good on the face of it because better returns = more funds, but it can lead to less incentive to advise people to reduce debt or invest in assets that are off-platform. It also creates an incentive for servicing clients with more funds to invest. This means that people with less funds get underserviced by the investment advice market. And to my mind, advising someone with $300,000 of assets isn’t twice as hard (nor twice as risky) as someone with $600,000.
- Most lawyers and accountants charge fees based on hourly rates. This isn’t conflict-free either. It can create an incentive to spend more time than necessary. Although in my experience this doesn’t happen often at an individual level. But it disincentives investing in finding more efficient ways of providing services. There is an incentive to “mow grass with scissors”. It is interesting that in this age of automation, the cost for many basic professional services hasn’t substantially decreased, and in many cases the costs have increased.
- Charging fixed fees for services create conflicts. If you’re going to be paid the same amount no matter what quality work you do, why go that extra step and spend that extra time? There is an incentive to cut corners. (This is also applicable for asset-based fees or scale fees.)
I’m not saying that people who use these remuneration structures are putting their own interests over their clients’ interests. In my view, most people are honest and sincere and want to do the best for clients. And over the long-run, having satisfied clients is the most sustainable way of doing business.
But I do want to point out, every remuneration structure introduces conflicts of interest and involves incentives that may not mesh with the interests of clients. Some structures may be better than others. But ultimately, no one is conflict free.
If everyone is biased and everyone is conflicted, should we just give up? Of course not. Some people are more biased than others, and some people are more conflicted than others. The more closely your biases and interests align with those of your clients, the more likely the outcomes will be better for the client.
This blog is made possible by Fairhaven Wealth, my independent, fixed-fee, advice-only financial advice business.