Whom Should You Turn to for Independent Investment Advice?

Whom Should You Turn to for Independent Investment Advice? 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? Cousin Bernie?

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 independent advice.

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 sell product."

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 investors.

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 customers.

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 shortcoming.

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 understand.

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 commissions."

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 appropriate investments.

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 the two.

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 client assets.

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 concern.

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 under management.

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.