October 19, 2021

Spotting Common Conflicts of Interest: What Every Investor Needs to Know

In Wealth Strategy

Kim Rosenberg
Contributions from: Kim Rosenberg, CFP®

A conflict of interest is anything that puts the investor at risk for the personal gain of the financial professional. Such conflicts of interest generally put the interests of the professional ahead of the investor, and in some cases can even cause harm to the investor as a result of a financial professional’s outside interests.

As an investor, there are certain conflicts of interest you can learn to spot – and avoid – to help protect yourself and your money from potential harm by representatives of the financial industry.  Here’s a quick rundown every investor can use to identify conflicts of interest and ways you can avoid or minimize your exposure to conflict risks.

What are examples of conflicts of interest?

Conflicts of interest in finance can come in many shapes and sizes. When we start working with a client, we often field many financial questions that would affect the size of the portfolio we manage – either making it larger or smaller.  As with many fiduciaries, we are paid on a percentage of the assets that we manage directly.  When we begin an engagement with a new client, we build a balance sheet to gain a full understanding of all their assets and liabilities, a cash flow projection to predict cash needs and future savings and several long-term plans (aka “vocational freedom” models) to provide confidence that their portfolio and future savings will be sufficient to meet their desired goals.  During this phase of wealth planning, we encounter many of the following questions from our clients.  The response you receive from your financial advisor could prove to be a conflict of interest if not answered appropriately.  Here are some common questions:

Should I pay off my mortgage?

  • Our best practice is to align a client’s target retirement date with the payoff of their mortgage.  This reduces their cash needs in retirement, and enables us to invest more aggressively while the client is still working so that ideally the portfolio rate of return outperforms the mortgage interest rate.  When clients retire, they typically move to a more conservative portfolio and this “spread” is not as advantageous.  Additionally, clients appreciate the peace of mind of going into retirement debt-free.  Some clients choose to retain very low interest rate debt into retirement and others want the peace of mind of paying off their mortgage as soon as possible.  All of these factors are important in the decision making – the client’s peace of mind should ultimately drive this decision.
  • A discussion about paying off the mortgage should include disclosure that the client would pay more in advisory fees if the mortgage is not paid off, and assets are left invested with the advisor.

Should I sell my company stock?

  • Our best practice is to build out a long-term plan model to help our clients define what their goals are and how much risk they need to take in the markets to achieve those goals.  Owning a concentrated position in one stock brings more risk to the plan than holding a diversified basket of high-quality stocks.  Therefore, if a client’s portfolio and future additions are already sufficient to meet all of their desired goals, we focus on what risks we can minimize.  A common rule of thumb is that holding more than 10% of your portfolio in any one stock brings unnecessary risk to your plan… that one stock could far outperform the market (think Amazon!) or it could far underperform the market (like Exxon, or worse yet Washington Mutual).  The issue is that it is unpredictable.  In order to bring confidence to our clients that their long-term plan is one they can rely on, we recommend holding no more than 10% in any one stock.  This often leads us to the recommendation of having a consistent plan to diversify your company stock.
  • A discussion about selling company stock should include disclosure that the client would pay more in advisory fees if the company stock was sold and reinvested with the advisor.

Should I buy a rental house?

  • Our best practice is to educate our clients about the pros and cons of owning a rental house.  The pros are that if the property is well-chosen, the returns can be higher than a diversified portfolio; rental homes offer some tax benefits and can be a consistent stream of income.  Probably the most desirable aspects of a rental home is that it is a tangible asset – unlike stocks and bonds, you can walk on the property, you can live in the house and because the house value doesn’t trade on the stock market, values feel like they are much more stable over time.  The cons of owning a rental house is the time it demands from the property owner to find tenants, manage repair requests and address problems as they arise.  Outsourcing this work reduces your return.  Some properties don’t appreciate as quickly as others, and some tenants are much more difficult than others.  Overall, owning a rental property can be very rewarding and profitable or it can turn out to be a hassle that may not be worth the higher returns.  Again, this is a very personal decision and one that requires education, discussion and a transparent conversation around the potential conflicts of interest to arrive at the optimal answer for each client.
  • A discussion about buying a rental house should include disclosure that the client would pay more in advisory fees if the client does not buy a rental house, but instead leaves assets that would be used for a down payment or house purchase invested with the advisor.

We also encounter situational potential conflicts of interest, such as

  • Serving a couple that have been long-time clients and are now going through a divorce
  • Working with siblings, parents or children of clients
  • Working with co-workers of clients

In many instances when working with generational wealth, close family (or business) friends, or in cases where a family situation is changing, there are unwritten benefits in developing a clear understanding of the family dynamic.  That said, individual client privacy is also critical.  Our industry standard is to communicate to all interested parties, and make sure everyone understands we do not share confidential information amongst our clients in any situation. We feel that this level of transparency builds trust and confidence in the advisor-to-client relationship.  To ensure complete confidentiality is kept internally, often we will split the clients across different advisory teams, which in turn helps reduce  the possibility of conflict of interest.

Investor Tip

Under the Investment Advisers Act of 1940, investment advisers are required to disclose conflicts of interest in Part 2 of Form ADV.

  • Always request a copy of Form ADV from your financial professional and make sure you fully understand it.
  • Ask questions if anything is unclear.
  • Take a close look at Part 2, which requires investment advisers to prepare narrative brochures that include plain English disclosures of the adviser’s business practices, fees, conflicts of interest, and disciplinary information. Make sure that you are receiving annual summaries of any material changes to the brochure along with either a revised brochure or an offer to deliver a copy of the revised brochure.

Due to these potential conflicts of interest the answers to these questions are important to determine if you are working with a true fiduciary.  All investment advisors registered with the SEC or a State securities regulator (Registered Investment Advisors or RIA) must act as fiduciaries. Broker-dealers, stockbrokers and insurance agents are only required to fulfill a “suitability obligation”. This means that while the advice they give you may be suitable to your situation, there’s wiggle room. That wiggle room could open up the possibility of recommending higher priced products that yield more commissions for the broker over similar, lower-cost options.

Coldstream and its advisors are fiduciaries, meaning we are obligated to put your interests first, ahead of our own, when providing transparent and objective advice in managing your assets. Our role as fiduciary sets us apart from other investment brokers and money managers. We must – at all times – serve your best interests. Visit to talk with an advisor today.

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