Know the bias

This issue of the Medical Post celebrates 60 years of informing doctors about important topics and advocacy. The importance of informing and advocating for ourselves financially has risen over the last few decades. Good financial health underpins our practice. My columns have been focused on knowledge and considerations for making good financial decisions. Still, we also hire professionals to help us. Those professionals can provide important advice, expertise, perspective and services. They usually have good intentions. However, they are also human and influenced by incentives and biases. Understanding those can help you to be vigilant, question and advocate for yourself.AccountantsAccountants deal with numbers. Pretty objective. However, tax planning is nuanced and there is still potential for bias. For example, they get paid more for doing corporate and personal taxes than personal taxes alone. That could bias advice toward incorporating early or in cases when its benefit is questionable. Having a second corporation, like a holding company, also generates more revenue for the accountant. There are times when incorporation, or adding a holding company, are great strategies. However, I have also seen them used for no logical reason, and colleagues wondering why they did it after years of higher costs without any benefit.This is not to say that accountants purposely advise people to their benefit and their clients’ detriment. I don’t believe that. Often what may have been good advice 10 to 15 years ago has changed. Confirmation bias makes it easier to ignore new evidence or interpret it in a way that benefits us or conforms with our beliefs. Like other humans, accountants are more vulnerable to bias if it is a complex situation, the change requires more effort and the action is not egregious.You have the most incentive to get optimal tax advice. Getting the best advice also depends on you sharing relevant details with your accountant. If you leave blanks, they may make biased assumptions. So, become aware of how a corporation works and how to keep your corporation tax efficient.Financial advisorsThe influence of incentives for financial advisors can be confusing because there are multiple business models.“Free” advisors get paid by institutions for selling their products or funds. The fee you pay is baked into the management expense ratio (MER) of those funds. It is partially why bank mutual funds have such high fees. Academic and real-world data have shown that higher fees are related to worse long-term performance. To compound that problem, Susan Christoffersen (currently dean and professor of finance at University of Toronto’s Rotman School of Management) and others in 2013 showed that advisors are more likely to put their client’s money into funds that they are affiliated with or that pay higher commissions. A 2015 Canadian Securities Administrators study corroborated that.“Fee-based” advisors charge a percentage of your assets under management (%AUM) each year. This helps reduce that product incentive. However, it is still not a guarantee that they will use lower cost and more effective funds. You pay both the %AUM fee and the fees embedded in the products used. So, you must ask about the total cost. If they use high-cost funds, you should critically question why. Also be aware that while they may not get paid to sell you insurance or private equity, they may receive referral fees for connecting you with people who do. They are supposed to disclose that to you.One of the arguments used by fee-based advisors to show that their incentives are aligned with yours is that the more your money grows, the more they get paid. It is usually true that you want your money to grow! However, you should also consider where your goals may deviate from the %AUM incentive. For example, if your goal is to put money into a real estate purchase for personal use or as an investment, that is money that is not invested through the fee-based advisor. If your goal is to spend or give away as much of your money as you safely can while alive, then that is also money drawn from your portfolio sooner. These actions decrease the %AUM and your advisor’s income.One of the most valuable things a financial planner can do for you is to help you spend with confidence to achieve your goals. Early on, that usually means investing more. Just be aware of the potential biases, if the focus seems to be on how to amass the most assets rather than how to use them. Ultimately, money is for spending to achieve your goals.“Fee-only” advisors get paid a flat rate. The name is close enough to “fee-based” that they often get confused and the nomenclature is not standardized. Fee-only advisors may also go by “advice-only” or “fee-for-service.” The fee may be hourly, a set amount for a defined scope, an ongoing retainer, or some combination of those things. Regardless, they do not have an incentive based on how much you have invested or in what—although they could still receive a referral fee.The main financial incentive for a fee-only advisor is for you to come back again for more help. That may be good or bad. Providing good advice and building trust is more likely to retain clients—good for both parties. One of the challenges with advice-only is that you must still implement the plan. That can be made relatively easy or it can be complex. A good financial plan is one that you can implement. If the advice is not readily implementable, it is a concern. That may reflect a sub-optimal plan for you or that you need more than “advice-only.”Insurance advisorsGenerally, insurance advisors also sell insurance and are paid to do so. That creates an obvious conflict of interest to sell as much as possible. Insurance is best to cover rare, but devastating events. Be wary of a bias to recommend insurance for everything that is possibly insurable.An insurance broker is familiar with the products and the types of costs people need to consider coverage for. As with other advisors, they may also favour what they are most familiar with when other options may be preferable. Common examples are manipulating insurance products to act as an “investment” or recommending insurance when building an emergency fund might better address the potential expense.When considering insurance, think critically about the coverage you require. An advisor may point out important things you had not considered—but be vigilant if what is being suggested doesn’t make sense. I described how I approach insurance in a previous column.Fiduciary dutyAs doctors, we are also incentivized to perform tasks and have biases toward using our hard-won skills. However, we also have a strong fiduciary duty to our patients that is backed by cultural, legal and regulatory mechanisms. Accountants and some financial advisors also have fiduciary duty to do what is optimal for you. In contrast, insurance brokers and many advisors are held to the lower “suitability” standard. They don’t have to advise the best option, but a suitable one. A fiduciary standard is preferable. However, it does not fully protect you.A fiduciary may advise what they believe is best for you, but that belief is impacted by their biases and training. An advisor trained by their firm may favour its products and strategies because they honestly believe in them. Finance professor Juhani Linnainmaa and others in 2018 showed that Canadian financial advisors held the same funds as their clients with the same level of average underperformance due to frequent trading, performance chasing and a preference for higher cost actively managed funds. That persists into their retirement. So, it is not likely commission driven. They are believers.Working togetherA good advisor can bring expertise, a different perspective and tools to objectively evaluate your financial situation. They may challenge some of your biases, help you to manage or change behaviours and reach your goals. However, they are also human and have their own biases and incentives. Awareness of those can help you to be vigilant. Base knowledge of personal finance, investing and taxation helps you to recognize when advice may not be optimal for you and to advocate for the best results from your financial team.Dr. Mark Soth is a practising academic intensivist in Hamilton and writes the Loonie Doctor blog.

Know the bias

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