Another worrisome conflict of interest emerges

Many of us in the wealth management profession work hard to reduce conflicts of interests. In fact, unlike 30 years ago, most advisers now charge clients a fee based on assets under management as opposed to earning only sales commissions. But while this goes a long way toward reducing conflicts, it certainly hasn’t eliminated them.

There are still potential conflicts based upon things like which custodians we use, or the ETF providers we choose. But here's another conflict that's rarely discussed and, until interest rates rose, wasn’t as big of an issue: Should clients use some of their savings and investments to pay for real estate, or should they use a mortgage or other collateralized debt?

Many years ago, I had a client who was nearing retirement, and she came in to do some cash-flow projections. She had a mortgage on her home that would be paid off in about 12 years. She had a sizable amount in both qualified accounts and a brokerage account.

Interest rates were quite high back then, as they are today, and her loan had a rate of around 7%. I suggested we take some funds out of her brokerage account and pay off the mortgage. There were plenty of fixed-income funds and munis to choose from, so capital gains weren't an issue.

After we analyzed the impact on her income taxes (she was reluctant to give up a deduction), I showed her that eliminating the mortgage would free up quite a bit of cash each month. She loved the idea, and so we liquidated some investments and sent her the cash, and she paid off the loan.

Two weeks later she dropped by my office to say, “Thank you.” She realized that my compensation was based upon the amount of money we managed, and she appreciated my integrity.

With interest rates so low this past decade, one could easily make a case for having a mortgage, margin loan or other collateralized loan. But it is much more challenging in the current environment. If a client is paying 7% or 8%, there is no certainty that they will earn more than that from their investments.     

Today, when a client is buying a second home, financing a boat or simply borrowing from their portfolios, it's incumbent upon us to let them know there is a conflict in our advice. Further, it's prudent to contemplate this conflict when we're analyzing a client’s financial plan to ensure that we aren’t putting our own interests above theirs.      

It is an easy decision to tell a client to keep a mortgage when cash is paying a higher interest rate than what the client is paying on the mortgage. But as time goes on, we will encounter a greater number of situations where it will be in the client’s best interest to take a withdrawal from their investment accounts. Being cognizant of the conflict, and disclosing that conflict to the client, will go a long way toward ensuring that we are always doing what’s right.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with approximately $16 billion in AUM.