There are many different factors you should consider when choosing a financial and investment advisor. Perhaps the most important factor, however, is one that many people are unaware of: whether or not their advisor is legally obligated to make investment decisions that are in their best interest. This legal obligation is referred to as a fiduciary duty. Fiduciary is a fancy word that simply means an advisor is required by law to offer financial and investing advice that is best for the client, not for the firm.
Registered Investment Advisors vs. Broker-Dealers
All financial advisors fall into one of two broad categories: Registered Investment Advisors (RIAs) and broker-dealers. RIAs like Anchor are fiduciaries, while broker-dealers like Merrill Lynch, Morgan Stanley, Raymond James, Edward Jones, Ameriprise, or any bank or insurance company aren’t.
Broker-dealers are held to what’s referred to as a “Suitability Standard” when offering financial and investment advice, rather than a fiduciary standard. This means that their advice must be “suitable” for the client’s needs at that particular time. The suitability standard is less stringent than the fiduciary standard in terms of the advisor’s obligation to make recommendations that are in the client’s best interest.
In addition to the fiduciary obligation, the other main difference between an RIA and a broker-dealer is in the way they are compensated. RIAs either charge their clients a percentage of assets under management or a fixed or hourly fee. Broker-dealers, in contrast, receive most of their compensation through commissions based on the investment products they recommend and sell. This creates what is known as a “Conflict of Interest”. If your investment advisor is paid $10,000 to sell you an annuity or $5.00 to sell you a low-cost index fund, there is a huge incentive for them to sell you the annuity rather than the index fund, whether or not the annuity is in your best interest.
Here are some examples of how broker/dealers are compensated and the Conflicts of Interest it can create:
- Ameriprise Financial’s Client Disclosure Brochure is 92 pages long and uses the term “Conflict of Interest” or “Conflicts of Interest” 26 Times.
- The Edward Jones broker compensation disclosure is 54 pages long and specifically says “When we do business with you, the firm and our financial advisors benefit from fees, commissions and other payments from you and our investment providers. These financial incentives may create a conflict between Edward Jones’ interest, your financial advisor’s interest, and your own.”
- Merrill Lynch’s fee disclosure is multiple documents including “Client Relationship Summary”, an “Explanation of Fees”, and a “Schedule of Miscellaneous Account and Service Fees”
- Morgan Stanley’s disclosure document has links to at least 43 separate internal disclosures. The Private Wealth Management disclosure is 20 pages long and the Disclosure Document for Qualified Retirement Plans is 36 pages long.
Which Type of Advisor Should You Choose?
In deciding which type of financial and investment advisor you should choose, one of the main questions you should ask yourself is this: Do you want to receive advice that’s objective and based solely on what’s best for your situation? Or do you want to receive advice that could be influenced, at least in part, by how much money the advisor will make based on the recommendations?
The only way to ensure that the recommendations you receive from your advisor are total, 100% unbiased is to work with a Registered Investment Advisor. As a fiduciary, an RIA must offer financial and investment advice that is based on your best interest — not on his or her compensation.
Your interests will always take precedence over the advisor’s interests — specifically, how much money he or she makes — when you work with a Registered Investment Advisor.