Ethics 101 for Financial Advisors: What You Need To Know For Your Practice

How do advisors keep ethics at the core of their practice?

We’ve seen regulations meant to protect consumers and firms implemented in the last decade, and while compliance can sometimes seem like a hassle, the role of regulations is to make the industry fairer for everyone. Xtiva can help with a portion of that equation – software and other tools that make compliance easy. But the other side of regulation are the ethics that go into every firm’s practice.

Ethics plays a large role in the world of financial advising. While doctors must follow the Hippocratic oath, wealth managers have no such code of behavior. It’s up to each individual to determine how ethics fits into their practice. This is ultimately what differentiates different advisors and builds trust with clients

While there are regulatory agencies for advisors, the weight of decision making falls on the shoulders of those making client decisions. A recent academic study sheds light on this situation, arguing that financial advisors who are exposed to rules and ethics regularly actually become more ethical. In this sense, ethics can be taught. In this guide, we’ll explore ethics 101 and everything you need to know for your practice. 

Sales vs. Advice in Advising

One of the biggest ethical dilemmas is in the boundary between sales and advice. Even when placing the client’s best interest first, it’s difficult to avoid pressing too hard on the sales pedal. If a client wishes to play it safe when you know it might be in their best interest to choose a more aggressive strategy, when is it okay to use stronger sales tactics or bend the truth? 

Sales tactics aren’t inherently bad, as long as you’re being honest with your recommendation. However, there still might be such a thing as placing too much pressure on clients to follow your lead. 

In this type of situation, the “ethical” thing for advisors to do is to allow their clients to have the final say, even if it jeopardizes their financial plan. Will this reflect poorly on the advisor or interrupt the customer journey? If they take preventative measures, such as requiring the client to sign a disclaimer saying they went against their recommendation, it isn’t likely. 

It’s easy to see how murky the line is between sales and advice. Ultimately, this is something advisors need to work out for themselves. As long as they’re presenting an argument to their clients based on facts not feelings, they’re working under a strong ethical compass.  

Fee and Commission Ethics

Another ethical question for advisors is how they choose to be compensated. Advisors can charge a fee based on the client’s assets or they can take a percentage of any earnings as a commission. Like the situation above, there isn’t a single right or wrong option. As long as they’re licensed to do so, advisors can choose the structure that best suits their practice. 

A fee strategy means the advisor earns more if they take an increasingly aggressive approach to investing or growing the portfolio. On the other hand, a commission-based planner might use transactions to earn revenue (churning). Both types of compensation bring ethical challenges. It’s all about working in the client’s best interest regardless of the payment structure, but this is often easier said than done. 

Tips for Staying Mindful of Ethics

While it’s easy to say ethics are at the center of your practice, this is more difficult in practice. With so many new cyber threats, complex communication tools, and changing regulations, how do you stay mindful of your own ethical code? Try these tips:

Balance your own self-interest. 

Realize that rationalizing your own self-interest is only natural. That said, this is a mental trap that could jeopardize your own career. Frequently ask yourself “is this in my client’s best interest?” before making a recommendation.

Stay in your own lane.

With so much competition amongst advisors nowadays, it’s easy to fall for the race for success. Being motivated and wanting to reach new markets is a positive thing, but it could get you in trouble if you’re not careful. It’s important to stay in your own lane and mind your own practice rather than focusing on others. 

Create a safety net. 

Don’t be afraid to make your own personal safety net. This could be a simple question you ask yourself before making a recommendation to a client. One common ethical question is to ask whether you would make the same recommendation for a close friend or another family member. If yes, you’re on the right track. 

Understanding the Value of Trust

Ultimately, ethics comes down to one thing: creating value for your clients. By building trust through ethical financial planning, you’ll earn more over the lifetime of the client. As more regulations curb unethical practices, those who earn the respect and trust with their practice always reign supreme. 

In our modern advising world, the client should always understand and feel comfortable with each financial step. If the client and the advisor are both on the same page, this is an ethical transaction.