Investing is a process of negotiating many forks in
the road, and for investors who want help with those
decisions, the first hard choice is where to get
investment advice. A stockbroker? A registered
investment advisor? A financial planner? A banker?
Nowadays, even insurance agents, accountants, and
lawyers are getting into the act. With so many
professionals offering help, whom should you turn
to for independent investment advice?
The major players are brokers, financial planners,
and registered investment advisors (RIAs). Many
practitioners do not fit neatly into one of these
categories, however, and a practitioner's title may
not correspond with what she actually does.
Furthermore, some of these professionals may have
divided allegiances. If you wish to avoid those with
potential conflicts of interest, a reputable fee-only
investment advisor is the preferred source for
Who's Serving Whom?
"People treat the words `broker' and `advisor' as if
they are interchangeable," consumer advocate
Barbara Roper, Director of the Consumer Federation of America, said in an interview for Investment News. "Brokers, despite calling
themselves `financial consultants' or `financial
advisors,' are salespeople," she continued. "They
don't have a legal obligation to assure that you get
the very best product at the very best price."
A broker is an intermediary agent who
negotiates a purchase and sale between parties who
want to complete a transaction. A stockbroker,
including broker-dealers, handles financial securities
such as stocks, bonds, mutual funds, options,
futures, and so forth. A broker's registered
representative (often with the title of vice-president)
is a salesperson who is paid a commission for
bringing the parties together and getting the deal
done. "Their mission," observes Investment Advisor
columnist Larry Chambers, "is to build brand and
Divide and Conquer
Wirehouses and independent broker-dealers are the
two main broker categories. Wirehouses include the
big brand names such as Merrill Lynch and Morgan
Stanley. As expected,
their reps will sell you a stock, bond, or other
security. Beyond that, their investment bankers get
paid the big bucks create stocks and bonds for
companies, and these securities are then sold to
Wirehouses also create mutual funds and other
house brands - quite a lucrative undertaking. The
wirehouse gets paid once for selling its own
products, and then again for creating and managing
these products. In addition, these products
frequently bear higher than average fees. With a few
of these products, if a customer decides to sell, the
proprietary firm may be the only dealer that has any
real interest in taking the investment back and at a
price that richly compensates it.
Wirehouses often strike lucrative deals to pay other
brokerages for selling their products, and vice versa.
High commissions encourage sales of these favored
products - an incentive that may divert the
salesperson's attention from what's best for
You might say, "So what? This happens all
the time. When you visit a Ford dealer, it's not likely
that the salesperson will put you into a new Toyota."
Yes, it does happen all the time. The difference is
that a car buyer is likely to know beforehand that
Toyota dealers sell Toyotas, and Ford dealers sell
Fords. In contrast, many investors expect that when
they go to a stockbroker, the broker will direct them
to the best investments to meet their needs,
including investments that do not bear the broker's
in-house brand name.
Do the Right Thing?
But neither car salespersons nor stockbrokers have a
legal obligation to work for the customer. They are
both working, instead, for themselves and for their
employers. Their job is to put you into the vehicle -
investment or otherwise - that will generate a
significant commission for themselves and
significant profits for their companies. House brands
and other favored products are good for the
brokerage firm, but from an investor's point of view,
a broker's fidelity to his employer is a major
Now suppose that an individual broker sincerely
wants to do the right thing by his customers. He
soon finds that the pressure to sell selected products
is overwhelming. One wirehouse broker recently
told me that she had no choice. She had to put
investors into proprietary in-house mutual funds or
her firm would not count them as her clients.
Another former wirehouse broker told Investment
Advisor magazine: "You get paid more if people are
in equities instead of bonds or cash. Advisors are
motivated through the pay structure to keep their
clients in stocks."
Moving away from the wirehouse, a step in the right
direction is the independent brokerage. Its
distinguishing characteristic, according to On Wall
Street, a trade magazine for brokers, is that
representatives are independent contractors, not
employees. Independent brokerages are generally
small houses, perhaps regional or local. They may
sell investments from a wide variety of providers.
Some independents may actually try to focus on the
best interests of their customers, but the prospect of
payments for favored placements from wirehouses
and fund companies may divert them from that goal.
Some independent brokerages have created their
own proprietary brands that their reps are
encouraged - or even mandated - to sell.
A Tiger and His Stripes
The Securities and Exchange Commission (SEC), as
well as the New York and Massachusetts attorneys
general, are now looking into commission
arrangements among investment firms, and
regulatory changes are likely. But Wall Street is Wall
Street. Don't expect the hungry tiger to shed his
stripes. Instead, expect the regulators to demand
more disclosure, and expect brokerages to devise
ways to make that disclosure difficult for investors to
Although the SEC, by law, governs the marketplace,
the SEC leaves it up to the National Association of
Securities Dealers (NASD), a self-regulatory industry
organization, to monitor day-to-day activities of
stockbrokers. The SEC or other authorities step in
occasionally to firm up or enforce loosely applied
regulations, or to enact new regulations as needed.
In contrast, registered investment advisors are
regulated either directly by the SEC or by state
governments. Anyone who gives investment advice
in return for compensation is required to register
with either the SEC or their state government unless
the advice is "incidental" to their business. For
example, a stockbroker or an accountant is
permitted to offer investment advice when that is
incidental to engaging in their respective businesses.
More recently, however, brokers, insurance agents,
lawyers, accountants, and bankers have been
developing investment advisory services by either
expanding their "incidental" usage or by buying an
investment advisory firm or by affiliating with one.
Both stockbrokers and advisors must comply with
strict, but different regulations. The NASD's
"suitability" rule requires stockbrokers to collect
information about a customer's investment
objectives, financial and tax status, and other related
information before making a recommendation that
is "suitable" for the customer. However, as
mentioned earlier, brokers may be strongly
encouraged to direct customers to investments that
are more suitable for the broker's firm than for the
investor. "In reality," noted the Economist magazine
earlier this year, "broking firms have every reason to
push in-house products, thus earning fees from sales
and management, or outside funds carrying high
Registered investment advisors, on the other hand,
are "fiduciaries," individuals who are expected to act
in their client's best interests and to disclose all
conflicts of interest to their clients. This advisor
fiduciary standard is widely considered to be more
stringent then the NASD's suitability regulations
governing sales by stockbrokers.
From Commissions to Fee-Only
Registered investment advisors fall into one of three
categories: commission-based, fee-based, and fee-only.
Commission-based advisors are similar to brokers
in that they are paid a fee for selling products.
Although commission-based advisors may offer a
variety of products, the temptation to play favorites
is great, either because some products offer higher
sales commissions or because their parent firm
restricts what they may sell.
In contrast, fee-only investment advisors do not
accept commissions. Although this does not
guarantee ethical behavior, it certainly promotes it.
Fee-only advisors are more able to exercise their
independent judgment and direct clients into
Fee-based advisors, the third group, drink from both
troughs in that they engage in both commission sales
and fee-for-service arrangements, frequently mixing
Fee-only advisors may be paid in several different
ways. Sometimes they charge hourly fees or are paid
a retainer. More commonly, however, fees are based
on a percentage of assets under management, an
arrangement that directly aligns the advisor's
compensation with building client wealth. Under this
arrangement, the more a client's managed assets
increase in value, the greater the financial reward for
the fee-only advisor. This gives the advisor a strong
incentive to keep costs low and focus on growing
In contrast, commission-based practitioners are paid
for making the sale. Whether a customer's assets
actually grow as a result is, unfortunately, of less
The last group is financial planners. Planners are
neither licensed nor regulated in most states, and
anyone can use the title. However, many
practitioners who call themselves financial planners
are actually registered as investment advisors.
A financial plan may be brief, perhaps based on
short answers to a few questions, or imposing,
perhaps a large notebook filled with impressive
graphs and charts. Neither of these, however, speaks
to the quality of the plan. Computer programs
widely used by planners can generate reams of
impressive charts and graphs, and language that
looks and sounds authoritative, but the value of a
plan depends not on weight, but on quality on the
understanding, knowledge, and skill of the planner;
and on how well the goals and objectives of the
investor are addressed.
All the Difference
I mentioned at the onset that a reputable fee-only
investment advisor is the preferred source for
independent advice, so you already know my point
of view. I started Cascadia Investment Consultants
as a fee-only investment advisory firm because I
believe this arrangement exposes my clients to few,
if any, conflicts of interest. To directly align my
interests with the interests of my clients, my fees are
usually based on assets under management. I work
hard for my clients, and the more I grow their
managed assets, the better I do too.
Surprisingly, stockbrokers appear to like the fee-only
advisor model, because many are working overtime
to make their businesses look like those of registered
investment advisors. Brokers have started to offer
more products and to charge fees based on assets
It's an illusion. Salient differences remain intact.
"[Brokerage firms] are doing what they can to make
it seem they do what we do," a fee-only advisor
recently told Investment News. "Prospective clients
come in all the time and say, `I'm talking to two
financial advisors: you and this guy at Merrill Lynch.'
It makes you cringe."
Any of the many business forms described here could
be managed in the best interest of clients, but in
actual practice, the road diverges at the intersection
of compensation. One green light is when you find
that the advisor's interests are truly aligned with
yours. It could make all the difference.