Not all advisors are alike; and it's worth knowing how to tell them apart.
While the overwhelming majority of investment and financial advisors are honest, reputable, qualified, and provide quality work for loyal clients, those who are looking for a potential advisor do face a daunting task. It isn’t easy.
Some are simply pushing high-commissioned products trying to “build production” because they have to meet a quota to keep their desks. Others, also chasing commissions, are simply hawking annuities – indeed, some brokerages specialize in annuities and buy tv advertising touting the benefits (without disclosing the drawbacks) – all the viewer hears is “our clients don’t lose money”.
So, who’s who? And, how do you recognize the standard of care you desire?
- Some are licensed for investments, some for insurance, and some for both.
- Some are captive (they work for a known, well-established firm), and some are independent. Among the independents are both solo practitioners and practice ensembles with several advisors.
- Some are brokers (commission-earning registered representatives), some are Registered Investment Advisors (RIAs) who are compensated by fees; some are hybrids (registered representatives who are also associated with an RIA firm and can accept either form of compensation.
The Legal Requirements
Here is where “the rubber meets the road” – it may be the most crucial issue.
A broker is held to a “suitability” standard. This doesn’t mean many brokers don’t operate at a higher standard and, indeed, many do; but, this is the legal requirement. An RIA must adhere to a fiduciary standard. Here’s what all that means:
The Suitability Standard
There must be a reasonable basis to believe that the recommendation is suitable for the customer, based on information obtained through reasonable diligence to obtain the customer’s investment profile.
The Fiduciary Standard
All decisions made for a client must place the interests of the client ahead of his/her own at all times;.
For example, a broker can make a decision based on which recommendation pays the highest commission and still be within the legal standard, as long as the recommendation is suitable. The RIA, however, must place the client’s interests first, ahead of his/her own.
Brokers are regulated by FINRA; RIAs are overseen by the SEC (if assets being managed exceed $100 million) or their individual state. Brokers must obtain and maintain a Series 7 general securities license and pass a Series 63 state exam. RIAs must pass a Series 65 exam, although in some states certain designations are accepted in lieu of the exam. California requires that RIAs must have passed the Series 7, as well.
The Hybrid Model
A registered representative (broker) may also be affiliated with an RIA firm, which is often the case where investments are sold – just look on the business card to see if you see something like, “Securities offered (or provided) through XYZ Securities”. If so, the firm is a broker-dealer for your registered representative. And, as I said, the firm is also an RIA and the rep is an RIA associate.
This allows the rep to provide planning while wearing his/her RIA hat, observing the fiduciary standard; however, when it comes time to make investment recommendations, the rep is then able to put on the registered representative hat, which means the fiduciary standard no longer applies and the suitability standard takes over. The client is seldom aware of the switch. Even when making recommendations under the suitability standard, the hybrid can accept fees, generally asset-based, for some assets while earning commissions on others.
Many Registered Reps, RIAs, and hybrid advisors are also licensed for insurance. It’s also true than some aren’t. It really depends on the type of services they wish to provide for their clients. My own career path followed this route:
- Captive registered representative in a major national firm, where I was also licensed for life and health insurance. Compensation was pretty much all commissions in those days.
- Independence: I opened my own office as an independent registered representative offering securities through an independent broker-dealer. I maintained my life and health insurance license. When the broker-dealer became an RIA, I became associated and began offering institutional managers to my clients on a fee basis. Compensation evolved toward fees as I began converting existing clients and discontinued commissioned sales. I did maintain my life and health insurance licenses.
- Independent RIA: I became an RIA and dropped by broker-dealer association, which meant going 100% fee-only for all investment related business. In order to be “pure” fee-only, I dropped my life and health insurance licenses. I operated this way for about five years. There's more information about my practice on my site.
I reacquired my life insurance license last year not long after a client I’d referred out to a life agent said to me: “Let me get this straight. Are you telling me you think they’ll do a better job for me than you will?” Since insurance plays such an integral role in estate planning and financial security, I decided it belonged back in my core offering; however, since ongoing management oversight isn’t generally an issue, I was comfortable receiving commission rather than fee compensation (I guess I should point out that whenever an insurance product is needed that includes investment components requiring ongoing management oversight, only no-load products are used and compensation is by fees only. Health insurance is something I feel more comfortable referring to a health insurance specialist.
Ask the prospective advisor to answer the following in writing, then date and sign:
- Are you held to a fiduciary standard in all dealings with me and my financial affairs? Will you acknowledge that status in writing?
- Do you provide full service, comprehensive financial planning services as well as investment advisory services?
- If you provide full service, comprehensive financial planning services, are these services performed by individuals that have obtained the Certified Financial Planner (CFP®) certification?|
It should be noted that some well-qualified, quality advisors do excellent work but work in firms (a captive relationship) that are dually-licensed (broker-dealers and RIAs) that will not allow their registered reps to sign such a document for fear of the obvious liability it might create. This may not be a reflection on the representative, but it does help identify the culture or environment you could be working within.
Conflicts of Interest
These are always required to be disclosed. And, while some firms tout the claim they have no interest conflicts, this is seldom, if ever, true. Personally, I think we all have conflicts and I have yet to see any advisor, including myself, who doesn’t.
- Commissions: Higher vs. lower commissions
- Fees: Depends on the form of the fees structure
- Asset based – A recommendation to pay-off the house reduces the assets under management and the advisor’s compensation.
- Hourly - Padding hours worked increases the advisor’s income
- Flat fee – Reducing the time spent, and maybe quality, increases profitability
Of course, there is a ‘flip side’ to all of this. The existence of commissions, for example, allow smaller investors to access professional advice they otherwise wouldn’t pay for – though many smaller investors are comfortable using “magic box” online solutions. Commissions also may inhibit frequent trading or changes, which seldom help.
Likewise, asset-based fees do provide an incentive for the advisor to limit risk in larger client portfolios, since the advisor’s income suffers when the portfolio value suffers.
Hourly or flat fees, while they sound good, can have a negative influence. Many people will refrain from seeking advice or help simply to avoid a fee. I have seen cases where a $500 savings resulted in a $100,000 mistake.
Maneuvering the maze isn’t easy and can be confusing; and many other well-meaning and excellent advisors will surely have their own thoughts on this; but, this may help get you started.
 I’ve always been skeptical of professionals who hold a laundry-list of credentials and licenses. It’s been my experience that many of the credentials often turn out worthless and the licenses meaningless, since there would be just too much ongoing required reading to really stay knowledgeable.
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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.
The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.