Brokerage firms have for many years built the illusion that they serve individual investors. In reality, their representatives are commission based salesmen. But, you won't find that on their business cards. No, they call themselves "financial consultants" or make some other attempt to look like something that they are not. They frequently add designations like CFP (Certified Financial Planner) or ChFC (Chartered Financial Consultant) to their resume, but any financial planning advice that they offer is strictly incidental to the sale of a product.
Commission based sales has been extremely lucrative for brokerage firms. But, beyond the issue of brokers masquerading as advisors, commission based sales creates very obvious conflicts of interest. Will a commission based salesman for a brokerage or insurance firm pick the product that is best for the client or the product that pays the highest commission? What standard is the salesman held to? The standard is called 'suitability', which simply means that the product is suitable for the client. It does not mean it's the best choice. Who enforces this standard? NASD -- The National Association of Securities Dealers. NASD is not a government agency. It is a selfregulatory organization made up of brokers. A broker or insurance company salesman has no fiduciary duty to his or her client. Instead, the standard of suitability and the need for corporate profits guide their behavior.
You might think that you would see the commissions that are being taken out of your account when you do business with a broker or an insurance company representative. Unfortunately, you often don't. This is particularly true when you purchase a mutual fund through a brokerage firm. Most firms like to sell shares of mutual funds ' called A class shares ' that typically pay the brokerage firm 5% or more. This is deducted from your investment immediately. But, does it show up on your statement as a line item that clearly explains what happened to your investment? Of course not. Brokerage firms have made an art form out of hiding fees.
"You should fire your broker and find an investment advisor. Brokerage firms would like you to think that they perform the same functions as investment advisors. Many brokers call themselves 'financial consultants' or 'financial advisors'. But they are not the same as independent investment advisors... an investment advisor's fiduciary duty is on a higher plane, like that of a lawyer, a trustee, or the executor of an estate." - Arthur Levitt, Former SEC Chairman
Unlike brokers, Registered Investment Advisors have a fiduciary duty to their client.
They are legally bound to put the client's interest first, including putting it ahead of their
own interest. This is vastly different from the standard of suitability. Registered
Investment Advisors are regulated by state and federal authorities, not NASD. This is a
big step in the right direction, but it doesn't go far enough. Many, if not most, Registered
Investment Advisors still work on a commission basis. The same conflicts of interest
exist with them. Others call themselves "fee-based". This is a meaningless term that is
also used in the brokerage industry. These are advisors or brokers that get paid by both
commission and fees. The only form of compensation that guarantees an advisor's
objectivity is fee-only.
Fee-only advisors do not accept any form of commission from the sale of any product.
This means that the advisor is free to choose the best product for the client. Fee-only
advisors are still relatively rare, but their ranks are growing rapidly. It's an ethical way of
compensating the advisor and it fosters trust between the advisor and the client. All fees
are clearly disclosed. When you interview an advisor that you may want to work with,
one of the most important questions you should ask is "How are you compensated"?
Unlike brokers, Registered Investment Advisors are required by state and federal law to
provide prospective clients with a document called Form ADV Part II. This document
describes how the advisor firm operates, including how fees are paid. Read it and
understand it. However, there is very important information that is contained in Form
ADV Part I concerning the regulatory history of the firm. This section is available online
or you can request it from the firm. You should avoid any firm that
hesitates to make it available to you.
CFP, ChFC, ABC, XYZ ? new designations seem to appear every day. It's not uncommon to find financial product salesmen with several of these listed after their name. Is it important? They certainly want you to think so. The organizations that offer the designations spend a lot of money to convince consumers that their designation is the "gold standard". Unfortunately, none of these designations guarantee more than a very basic competency, often in a very broad range of subject matter. A CFP or ChFC can be valuable for a financial planner. But, these designations have very little to do with asset management. In fact, both require only a single basic investment course that can be taken online. A CFA can be a valuable designation for a portfolio manager, but does nothing to denote competency in financial planning.
The best course of action is to work with a fee only Registered Investment Advisor that offers a multi-disciplinary team approach to managing your finances. This may include planners with CFP or ChFC designations, experienced asset managers that may hold the CFA designation, CPAs, and estate planning attorneys. It can be difficult to find a fee only firm with these capabilities, but it is well worth your effort to do the research required. Finally, be careful with recommendations from friends and family members.
They often lack the understanding that is required to select an advisor and are, instead, exploited by the salesman that handles their account and begs them for referrals. Do your own research before you choose an advisor. Your future depends on it.