by Jack Waymire
If you’re considering working with a financial professional, the first question on your mind is probably, how do I know a good advisor from a bad? Can I walk into any financial-services office and receive the same level of care over my finances and investments?
The short answer to the latter question is no. The short answer to the first question is, there is no short answer.
In order to recognize a good advisor from a bad, you have to first understand who an advisor is – or should be. In this post, we explain what makes an advisor different from a broker and why you should care about the difference. We’ll also share some strategies for helping you vet any advisor you consider working with before signing anything.
Brokers vs. Advisors
The first step to choosing a financial professional to work with is understanding the different professional designations used in the personal-finance industry. There are two main flavors of personal-finance professionals: Brokers and advisors.
Before the advent of the Internet and online trading, investors had to rely on a broker to place their trades for them. You would call your broker on the phone and tell him or her what you wanted to buy or sell. The broker would then place these trades for you, earning a commission for each transaction.
An advisor, on the other hand, was an individual who offered investment guidance. Your advisor would recommend investments and help you build a portfolio to achieve your goals. Once you chose a security to buy, the advisor would reach out to a broker who could perform the transaction for you.
Today, investors can place their own trades online, making the old-fashioned phone broker obsolete. As such, many brokers have expanded the services they offer into investment guidance. The result is a blurring of the line between advisors, or Registered Investment Advisors (RIAs), and brokers, or Registered Representatives. This blurry line only makes it all the more important for investors to understand the difference between the two so they can make the right choice when looking for investment guidance.
The Suitability Standard vs. The Fiduciary Standard
Brokers and RIAs are held to different standards of care when handling their clients’ investments. Brokers work under the suitability standard. They are required only to provide products that they reasonably consider to be “suitable” for their clients. This means that if you are looking for more income from your investments, your broker could recommend an annuity that provides guaranteed monthly income but also has a relatively high fee structure – and a very high commission to the broker. Your broker could recommend this annuity to you even if there are lower-cost income investments that may be better for you and your portfolio, because technically-speaking, this annuity is a “suitable” choice for someone needing income.
A Registered Investment Advisor could not recommend this annuity unless it was in your “best interest” to do so. This is because RIAs are held to a higher standard known as the Fiduciary Standard. Under the Investment Advisors Act of 1940, RIAs are legally bound to put their clients’ best interests first and foremost. In the Security Exchange Commission’s (SEC’s) Information for Newly-Registered Investment Advisers, they tell advisors that, as fiduciaries, they owe their clients “a duty of undivided loyalty and utmost good faith.”
The reason for this higher level of regulation and care is that advisors can make discretionary decisions regarding your investments without your immediate consent. For instance, when you hire an advisor to manage your investment account, (s)he may monitor the markets and choose when to buy or sell according to your stated objective without you having to get on the phone and say, “Go.”
Fee-based vs. Fee-only
Part of the “undivided loyalty” advisors are required to have means not being compensated in a way that creates any conflicts of interest between what is best for the advisor and what is best for the client. While brokers are compensated solely on commissions from the products they sell, RIAs are paid primarily through a fee. They will describe their fee structure as either “fee-based” or “fee-only.”
You can think of fee-based advisors as the broker-meets-advisor of the personal-finance world. Fee-based advisors skirt the line between advisors and brokers in their compensation structures by earning both commissions on products they sell directly to clients and fees for their advisory services. Since these advisors are not required to disclose how they are compensated to clients, there is room for conflicts of interest to occur.
Fee-only advisors, on the other hand, do not earn commissions or sell products directly to their clients. Their sole job is to find the best investment or product for their clients. To do this, they will work with outside brokers and other professionals who sell the products that meet their clients’ needs. As you can imagine, this significantly reduces the chances of any conflicts-of-interest but may complicate matters from an investment standpoint.
Brokers and RIAs are required by the SEC and Financial Industry Regulatory Authority (FINRA) to hold different licenses. To be a broker or Registered Representative, a professional must hold a Series 6 or Series 7 General Securities License as well as a Series 63 license (the Uniform Securities Agent State Law Examination license) to sell securities in a given state. This is important: All brokers and advisors must be registered in the state in which you live in order to sell you a product or offer guidance on your accounts.
RIAs must have a Series 65 license (the Uniform Investment Adviser Law Examination license) or a Series 66 (the North American Securities Administrators Association (NASAA) Uniform Combined State Law Examination). The Series 66 is equivalent to holding both a Series 63 and 65. As you might have guessed, having a Series 66 or combination 63 plus 65 license(s) is what enables fee-based advisors to both advise and sell products.
You can check the licenses your broker or advisor has for free on websites like BrokerCheck.com. The site provides the advisor’s or broker’s licensing history – i.e. which licenses (s)he has, when (s)he earned them and what states (s)he is registered to work in – as well as an overview of that individual’s work history. BrokerCheck will also alert you to any regulatory actions, arbitrations or complaints filed against the broker or advisor. If you want to dig even deeper, you can head over to your state securities regulator for state-specific information about the broker or advisor.
The Bottom Line
RIAs and Registered Representatives are very different finance animals. What this means from an investor’s point of view is this: Brokers, at least at the big firms, can get you access to a wide range of products, but they are not legally bound to get you the best price nor avoid conflicts of interest when recommending products. If you know what you want and have a clear understanding of what a fair price to pay for the investment is, a broker may suit you fine. If you would like guidance and are looking for someone you can rely on to be in your “best interest,” you would be better off with an RIA.
Assuming you land in the second camp, not all RIAs are created equal. You will still want to do your due diligence in investigating an advisor before signing on as his or her client. Verify his or her certifications on BrokerCheck and read client reviews when available. Ask to speak with other clients to hear about their experiences. When it comes to caring for your finances, you can never be too careful; it is your and your family’s future at stake.
Jack Waymire worked in the financial services industry for 28 years before he left to found the Paladin Registry (www.PaladinRegistry.com) in 2004. This investor education website was based on the Principles in Jack’s first book: “Who’s Watching Your Money? The 17 Paladin Principles for Selecting a Financial Advisor.”
The Registry also has a free service that matches investors to advisors who meet Paladin’s minimum requirements for competence and trustworthiness.
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