Investment Advice: is there really a difference?

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It can be overwhelming to research all the different financial advisory firms out there today. Who is a good advisor? Whom can I trust? Given this uncertainty, most people solicit recommendations from friends or family. They then hire the recommended advisor without examining alternatives or selecting the right person for their specific situation. In this post we try to provide clarity both on the different types of financial firms and the qualifications of the advisors who work for these firms.

Types of Financial Firms Offering Advice

Brokerage Firms – are probably what most people picture when they think of a “stock broker.” Although this category contains firms of all sizes, the most well-known are the national firms like Merrill Lynch (now owned by Bank of America), Morgan Stanley, and UBS. These firms are sometimes called full-commission or full-service brokers. They employ Registered Representatives (i.e., stock brokers) who sell investment products to clients and are paid commissions for completing transactions. The firms traditionally offer clients access to research on companies, a global reach, and capital market operations, including investment banking.

Independent Broker-Dealers (IBD) – share many attributes with full-service brokerage firms, but the Registered Representatives don’t work directly for the firm. They are independent contractors who affiliate with the IBD. This arrangement means the representatives often market themselves as an independent firm (i.e., “Joe Smith Capital Management”) with securities offered through their IBD affiliation. Advisors generally maintain their own offices, as opposed to having all the brokers together in a corporate location. One of the largest firms in this category is LPL Financial, although there are many IBDs of all shapes and sizes.

Registered Investment Advisors (RIA) – are a different animal in that they are paid for their services via disclosed fees instead of commissions; plus, they have a fiduciary duty to act in the client’s best interest. RIAs are registered with either the Securities and Exchange Commission (SEC) or with state regulators. Most RIAs are independent firms and don’t take custody of client assets. Instead, client assets are held by third-party custodians such as Schwab, Fidelity, and TD Ameritrade, with clients granting the RIA authority to place trades in their accounts.

Mutual Fund Companies – often large mutual fund companies also provide investment advice. Although there are some very good mutual fund families out there, investors should be aware of the inherent bias that will come with any advice provided by a company trying to sell you their own proprietary mutual funds.

Discount / Online Brokers – many of these firms, which traditionally catered to the do-it-yourself investor, have started to provide investment advice. Depending on the level of advice desired, they may provide some limited advice for free, or provide full “private client” services similar to a full-service brokerage firm or RIA (for a fee, of course). Generally, the strength of these firms is their web-site, low trading costs, and tools to help the do-it-yourself investor.

Types of Advisors

To confuse things even more, a firm may fit into more than one of the categories above. For example, a brokerage firm which may generally offer services on a commission basis through their Registered Representatives can also be an RIA offering advice for a fee. Conversely, an advisor with an RIA firm may also be affiliated with an IBD, offering some services on a commission basis. You will often see the term “fee-only” applied to pure RIA firms and “fee-based” for firms which offer some service for a fee and collect a commission for other transactions.

Registered Representatives (Series 7 licensed) – are employed by brokerage firms (full-service, IBD, discount, etc.) and are required to pass certain licensing requirements, including the Series 7 exam. As a broker, they are obligated to recommend only “suitable” investments to investors. They are paid via commission collected either explicitly (e.g., $100/trade) or implicitly (e.g., markup on bonds, 12b-1 fees on mutual funds, etc.).

Investment Advisor Representatives (IAR) – are affiliated with an RIA firm. IARs have a fiduciary duty to always act in the client’s best interest. RIA’s are paid a fee for their service, generally a percentage of assets under management. It is important to remember that an individual can be both a Registered Representative of a brokerage firm and an IAR. If you chose to work with an advisor who wears both hats, clarify which hat they are wearing in working with you, and if they are acting solely in your best interest, or are they just recommending a suitable investment.

Other Resources

For an additional viewpoint on these topics, I would encourage you to read an article in Kiplinger’s Personal Finance Magazine “Whose Advice Can You Trust?”

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