Investment Advisor vs. Broker
A statement I hear somewhat regularly is, “oh, I have a financial advisor” or “I have an investment guy.” However, what you may have is just a stock or mutual fund broker who is selling you different securities. In reality, he or she may not be advising you on anything and may only be selling you something for a commission.
We will take a look and examine the difference between a financial professional who is a broker and one who is an investment advisor/fiduciary. You will then be able to determine if your “advisor” is working for you or themselves.
While the two jobs may seem quite similar to someone who does not work in the financial world, investment advisors and brokers perform vastly different roles in the financial services field.
We are going to look at some of the similarities and differences between the investment advisor (also commonly called the financial advisor) and the broker. Be sure that you educate yourself on the differences so that you know what questions to ask your “advisor” to see if you genuinely have a real financial advisor or someone only selling you financial products. This will help you to choose someone who is acting as a fiduciary and with your best interests at the forefront.
First, we will start by looking at some significant key differences:
- Investment or financial advisors are paid a flat fee or percentage of the assets they have under their management to advise clients on securities and/or manage client portfolios. Instead of earning a commission based on the sale of a security or other financial product, they are paid a flat fee in exchange for independent, unbiased advice. (This is what you want if you are going to hire someone to look after your portfolio, retirement account, etc.)
- Brokers are paid commissions to execute trades, buy and sell assets for clients, or place a client into a specific type of financial product. Their compensation is dependent upon the sale of a security or financial product.
- Brokers and investment advisers are regulated by different entities and require different qualifications/licenses to operate. The Financial Industry Regulatory Authority (FINRA) regulates brokers, and The U.S. Securities & Exchange Commission (SEC) regulates investment advisers. Advisors and brokers are also subject to passing different licensing examinations to act as either an advisor or a broker.
- Both professionals are legally prohibited from giving advice that conflicts with their clients’ needs. In other words, the investments must be suitable for the client regardless of how the financial professional is paid. However, there is a significant difference between suitable versus what is best for you. Suitability does not always imply a fiduciary duty. More on this shortly.
In ancient times long before online trading, investing apps and self-directed accounts, accessing and utilizing a broker was usually just a luxury service that wealthy individuals enjoyed investing their money. Individual investors typically had very little or no means to access the market or a trading platform to make any trades.
What would happen is they would have to place their orders using a licensed broker, frequently by phone. In return, the broker would charge a healthy commission on the trade. However, the dawn of the “web-based” and discount brokerages throughout the country has drastically changed the role of the traditional broker. The traditional broker is quickly being phased out in exchange for the investment advisor who manages assets (more on the investment advisor below).
Those who want to trade on the stock market or in other securities no longer need to have a broker on speed-dial to execute their trades. People now have direct access to make trades, often with no commissions. Numerous online brokerage platforms now offer zero-fee trades and zero-commission trades.
Many brokers will still execute orders for clients. However, many have changed or just expanded their services to justify charging their still relatively high commissions. The commission-based model seems to be becoming a thing of the past, and if you stop and think about it – is someone working on commission acting in your best interests or theirs?
This is why as of June 30, 2020, the U.S. Securities and Exchange Commission (SEC) has ruled that brokers can no longer call themselves or market themselves as “financial advisors” or use any title that includes the word, “advisor.”
This is a massive step in the right direction as brokers typically do not offer unbiased advice. Their “advice” usually stems from a particular security or product they are trying to sell or promote. For example, if a broker works for a firm or company, they will often recommend only financial products that firm or company endorses, which may or may not be best for you and your goals.
I have had many clients come to me asking for me to review what their previous “advisor” put together for them. I then must be the bearer of bad news in telling them that they did not have an advisor. Instead, they had a stock or mutual funds salesperson managing their finances and retirement portfolios; and that they do not have a holistic financial plan but rather a collection of stocks, bonds, and mutual funds that they accumulated over the years.
Pretty scary if you ask me.
So, you might be wondering, what exactly is an investment or financial advisor, and how can I tell the difference?
Unlike brokers, investment advisors work for a flat fee or rate. When acting as an investment advisor, one is NOT permitted to work for a commission. Investment advisors also have a fiduciary standard or fiduciary duty. This means that they are always and legally required to act in the best interests of their clients.
Therefore, the investment advisor works on a fee-based system that allows them to give unbiased and transparent investment and financial advice, catered to individual client needs, goals, and objectives. Investment advisors will also often manage a variety of investment accounts for their clients.
For example, an investment advisor may work directly with their client to create an entire financial plan. This can include helping clients with tax, estate, legacy, mortgage, college savings, and retirement planning.
Investment advisors are registered with and regulated by the United States Securities and Exchange Commission (SEC), and sometimes by a state regulatory body or state securities commission. Investment advisors are also known to some as financial advisors, asset managers, investment managers, and wealth managers, to name a few.
A simple way to know if your “investment person” is an investment advisor is to ask them, “are you a licensed investment advisor representative?”
Investment advisors are also held to a much higher legal standard than brokers. In the United States, all registered investment advisors must adhere to the Investment Advisers Act of 1940. This act mandates that advisors must perform, “fiduciary duties in regard to their clients’ accounts.” “A fiduciary duty, which is legally enforceable under the Advisors Act Sections 206 (1)/(2), prohibits advisers from “employ[ing] any device, scheme or artifice to defraud any client or prospective client.”
The fiduciary standard also mandates, “affirmative duty of ‘utmost good faith’ and full and fair disclosure of material facts” as part of the adviser’s duty to exercise loyalty and care. This includes “an obligation not to subordinate the clients’ interests to its own.” Due to the importance of this fiduciary conduct, most investment advisers can make investment decisions for their clients without first getting the client’s permission.”
All investment advisors with $110 million or more assets under management must register with the U.S. Securities and Exchange Commission (SEC).
Testing and Licensure
Investment advisers and brokers have different training, testing, and licensing requirements. Brokers take their exams through FINRA, and investment advisors take their exams through the NASAA.
Brokers typically take the Series 6 and/or Series 7 exam depending on the types of financial products they will offer their clients. Alternatively, investment advisers must pass the Series 65 Uniform Investment Adviser Law Examination. This is a requirement before any investment adviser can provide financial advice for a fee. This exam is administered by NASAA and is regarded by some as the most comprehensive and challenging examination offering for financial professionals.
When surveyed, over 40% of everyday investors incorrectly thought that both brokers and investment advisors are required to act in their clients’ best interests. This was a part of a joint study directed by the Rand Corp. and the SEC’s Office of the Investor Advocate.
Things get a bit tricky when dealing with what is called a dual-registered representative. This is someone that is licensed both as a broker and an investment advisor. This can present somewhat of a conflict of interest, and it is vital to understand what capacity the financial professional is operating as at a particular moment.
Roughly 60% of the current 504,000 registered brokers in the United States are dually registered as both brokers and advisors. Are they acting as an advisor or as a broker/salesperson? I would certainly want to know if I was on the receiving end of their advice and suggestions. So, do NOT be afraid to ask!
The right financial advisor, who is a true fiduciary, can help you meet both your short- and long-term financial goals. They can assist you with retirement planning, investment selection, estate planning, and overall financial well-being. It is important to work with an advisor who is going to be your advocate and ally, who is going to do what is best for you and not for his or her wallet.
Do NOT be afraid to ask a financial professional what examinations they have passed, what titles they hold, and in what capacity they are acting in when assisting you. After all, this is your hard-earned money they will be managing and overseeing for you.
If you have questions or would like personalized advice, you can schedule a one-on-one call with Gary (an investment advisor/fiduciary) here: https://calendly.com/downes-dalessio/thin-line-financial