Importance of a Fee-Only Fiduciary Financial AdvisorSubmitted by Canty Financial Management on October 29th, 2019
The term financial advisor is a broad definition and encompasses a wide variety of financial professionals. Many advisors call themselves financial advisors even though they have no license, registration, or even education to back up their services.
When choosing a financial advisor there are countless options available. Two of the most common being Registered Investment Advisors (RIA) and Broker-Dealers. We find there are a few things to look out for when narrowing down your search for a financial advisor.
What is a fiduciary financial advisor?
Registered investment advisors (RIA) are by law fiduciary financial advisors. Fiduciary means they are required, by law, to act in the best interest of the client and to put the client’s best interests ahead of their own. Fiduciary financial advisors are investment professionals licensed with the U.S. Securities and Exchange Commission (SEC) or State regulators. The fiduciary standard is the highest standard of care in the financial advisor profession.
Many advisors such as broker dealers and certain investment bankers do not have a contractual agreement to act as a fiduciary. Rather, they have a “suitability” requirement, which means each investment they suggest must be suitable for the investor. Broker-dealers have no legal requirement to act in the client’s best interest at all times.
What is a Broker-Dealer?
A broker-dealer is an investment professional or firm who engages in the soliciting of securities to individuals as well as trading securities in their own account. Broker-Dealers are regulated by FINRA and the SEC. An agent is acting in capacity as a broker when they are selling or soliciting securities to individual clients. A firm as acting in capacity as a dealer when they are transacting securities in their own account and aiming to profit from these transactions.
Broker-dealers have a “suitability” standard. This means any investment recommendation they make to an individual must be suitable for the investor at that moment in time. This is a less stringent duty of care when compared to the fiduciary standard.
Differences in Compensation
One of the other major differences between a fiduciary financial advisor and a broker-dealer is the way they are compensated for their services. Typically, broker-dealers will earn compensation through the commission they earn for each buy and sell of a security. This fee structure can run into issues such as account churning. Account churning is an illegal act, occurring when an advisor intentionally places unnecessary buys and sells in an account to generate excess commissions.
Registered investment advisors typically earn compensation for their services based on a fee structure as a percentage of assets under management. The average fee for registered investment advisors today is around 1% of the assets under management. This fee structure better aligns the goals of the client with the goals of the advisor. As the account grows in value, so does the compensation to the advisor.
So Which is Better?
When deciding between the two, Registered Investment Advisor or Broker-Dealer, it is important to understand the services you will need. If you are looking for financial advice on an ongoing basis, we typically find registered investment advisors are a more beneficial option.
The RIA model puts a client’s needs ahead of the advisors and aligns their compensation with the overall goal of the client. A registered investment advisor is always required to act in the client’s best interest and the advice they give must be unbiased. Legally, RIAs must try to find low cost high performing securities in order to give the client the best chance of investment success.
Broker-dealers have a commission structure which can be easily manipulated. As there is no legal requirement to act in the client’s best interest at all times, a broker-dealer can pedal securities owned by their own firm. In this case it is difficult to receive unbiased advice as each recommendation has a underlying commission or benefit to the broker-dealer. Now there are some broker-dealers getting away from the commission structure, but many times they are still recommending proprietary securities sold by their own firm.
If you have any questions on the differences between Registered Investment Advisors and Broker-Dealers please don’t hesitate to reach out.