What are the Differences between Brokers and Fiduciary Advisors?
If you are researching financial advisors in Scottsdale, AZ you will soon realize that many types of financial advisors exist. There are financial professionals who work at banks, brokerage firms, investment firms, as well as financial advisory or planning firms. Picking a financial advisor is an important decision.
There are many factors you should be considering. When you start communicating with financial professionals it is important to know whether the advisor works as a broker or as an investment advisor. In this article, we discuss the differences between both of these types of advisors, and why it matters.
Brokers, Suitability Standard of Care, and Commissions
Brokers (often called stockbrokers when interacting with individual clients) are compensated by charging a fee or commission on the buy/sell transactions they perform on your behalf.
Brokers are regulated by the Financial Industry Regulatory Authority, also known as FINRA. They are held to a suitability standard of care, meaning that the broker must reasonably and with due diligence believe that a certain recommendation is “suitable” for the client’s situation.
In practice, this means that brokers are allowed to advise their clients to buy securities that will provide them with greater commissions. As long as the broker discloses any material conflicts of interest (such as receiving higher commission rates for the recommended investment).
Brokers ultimately work for their broker-dealer firm, unlike fiduciary advisors, who prioritize their clients above other obligations. Consequently, brokers work for their employer’s best interest, not necessarily their clients’
Although the risk may be small, investors should be aware of unethical broker practices. Brokers are typically compensated from transaction charges and commissions. This means they are incentivized to make trades in a client’s account.
The downfall of this can be when the broker makes excessive trading in a client’s account. This is called account “churning,” meaning the broker buys and sells securities unnecessarily in the client’s account to generate transaction fees.
Brokers may also receive compensation from their employer for bringing in a certain number of new clients over a specified period of time. They also have an incentive to recommend that clients purchase certain investments, often their brokerage firm’s own funds. Even if competitors’ investment funds have lower commission rates and would be more cost-effective for the client, as long as the broker’s fund is still well-suited (suitability standard of care) for the investor, current legislation allows brokers to make these recommendations.
More recent regulation has expanded broker-dealer responsibilities, primarily by increasing and explicitly defining the expectations for their interactions with clients and how they make recommendations and transaction decisions.
Regardless, the more limited suitability standard of care remains the status quo for brokers. Although most brokers will make decisions in their clients’ best interests, they do not have a legally enforceable requirement to do so.
Fiduciary Financial Advisors, Fiduciary Standard, and Fee-Only
Registered investment advisors are investment firms that employ individual advisor representatives (IARs). Firms and individual advisors are regulated by the Federal Securities and Exchange Commission or the regulatory agency in the state where the firm is located. It depends on the amount of assets under management (AUM) the firm has.
All investment advisors are bound to a fiduciary standard of care in all their dealings with clients. For IARs who make trading decisions or provide investment guidance to clients, full transparency and elimination of conflicts of interest are essential.
For example, IARs are required to report their personal securities trading for transparency purposes, and individual firms often develop additional ethical expectations for their own employees.
For those seeking guidance from IARs, the industry professional designations include the Certified Financial Planner (CFP®), Accredited Investment Fiduciary (AIF®) and Chartered Financial Analyst (CFA) certifications. CFPs® generally provide overall financial planning advice, which can include investment management, while CFAs often provide more in-depth or active portfolio management.
Fiduciary Standard of Care
Investment advisors are held to a fiduciary standard in all their interactions with and on behalf of their clients, meaning their client's interests come first and foremost. Advisors also have a duty of “best execution” regarding asset trading decisions, meaning that they must prioritize finding their client low-cost options for trading while ensuring that the trade is efficient and timely. In implementing strategic investment decisions, advisors cannot trade in their own accounts before they trade on behalf of their clients.
Advisors may sell products on commission, but they must disclose to the client all material ways the advisor might benefit from a certain piece of advice or purchase. Some advisors also sell insurance, for example, which generates commission fees when the client purchases a policy.
Fiduciary advisors can be compensated in many ways, but they are most commonly paid through receiving a percentage of the assets under their management. This fee structure aligns better with their client's interests since investment advisors are incentivized to maximize their client’s account value (as long the portfolio management remains in line with the client’s risk tolerance and reflects a reasonable portfolio allocation).
Advisors can also be paid through fixed fees, hourly rates, or commissions for trades or purchases, just like brokers (In this case they are considered ‘fee-based’. ‘Fee-based’ means that the majority of what they do is ‘fee-only’, but they may in certain situations sell commissioned products to their clients.)
However, the difference between fiduciary advisors and brokers is in the required standard of care. Fiduciary advisors must provide the client with all relevant information about conflicts of interest and must be able to support the claim that the recommended investment or advice is truly in the client’s best interest.
Clients who would like to avoid commission-based compensation entirely might prefer to work with fee-only fiduciary advisors. These advisers are compensated solely through hourly rates, retainer fees, or a percentage of assets under management, rather than through transaction fees or commissions.
As a result, fee-only advisors’ advice should be completely unbiased, since clients’ behaviors and decisions (unless they entail withdrawing funds under management) should have no financial impact on the advisor.
Which is right for you?
Unless you are certain you would prefer a broker to manage your investments, the wisest choice may be to work with an investment advisor who operates under a fiduciary standard of care. The fees you pay for their services will be more transparent than they would be with a broker, and the advisor can serve as a trusted partner rather than a broker’s more transactional relationship, in which brokers are motivated only to find you an acceptable solution, not necessarily the best one.
ARQ Wealth Advisors is a fee-only fiduciary firm that is committed to putting the needs of their clients above all else. We are a team of professionals, that includes: CFP’s, AIF’s, and a CFA. We take the fiduciary standard seriously. In fact, we have adopted the fiduciary standard’s best practices. If you are ready to get on the road to your best financial future, ARQ Wealth Advisors are here to help. Contact us today!