Financial Advisor vs Investment Advisor

Why You Need To Know The Difference: Financial Advisor vs Investment Advisor

financial advisor vs investment advisor debate

image: flickr/tunaboat

Financial Advisor vs Investment Advisor – the difference continues to blur.

Last year I did a post on the difference between  financial advisors and investment advisors that has brought quite a bit of inquires and questions from investors.

I noticed similar questions being sent to me, so I am going to revise last years post with much more detail.

I should point out that financial advisor has become a generic term within the industry. Even I use the term often.

However, structurally and legally the financial advisor who is a Registered Investment Advisor (RIA) is very different from the financial advisor who is stockbroker at a Wall St. firm.

To start off with here are a couple of key points:

Investment Advisors (RIA)

-fiduciary duty
-innovation comes from this area
-no products to sell, are typically money managers
-typically investment model based
-typically small business owner, privately owned
-has access to multiple firms (Fidelity, Schwab, FolioFN, TD Ameritrade, Trust Company of America, etc)


Financial Advisors (stockbrokers, etc)

-no fiduciary duty
-spend time selling
-firm products to sell
-quotas and sales contest
-MPT based
-work for large firm (Bank of America Merrill Lynch, Morgan Stanley Smith Barney, etc)
-access to only firm’s resources

I want to focus on a couple of those key points mentioned above:

I am asked quite often, “how are you different from my financial advisor and why should I care?”

I love this question. It gives me the opportunity to dish out the dirty little secrets about stockbrokers/wirehouse financial advisors and brag a bit about myself at the same time. With trust of Wall Street at an all-time low, I figure now would be a good time to add some more fuel to the fire:

Suitability vs Fiduciary

Did you know that your broker, aka Wall St Financial Advisor, may not be looking after your best interest? Did you know that this is mandated by law?

Most large firms are publicly traded, meaning they have stockholders to answer to. By law, firms are supposed to look after shareholders’ interests before clients’. In fact, board members of these firms have a fiduciary responsibility to shareholders, not their clients.

What this means is that your financial advisor at Merrill Lynch or Morgan Stanley is only required to make recommendations that are “suitable” to you. What happens if they fail to make suitable recommendations? Typically, the firm will settle in (or out of) arbitration with the client, and the financial advisor may get a slap on the wrist, or pay a small fine.

Registered investment advisors (RIAs) have a “fiduciary” responsibility to their clients. In the simplest terms, it means we have a legal responsibility to put your needs ahead of all others, including ourselves and our firm. If I fail to do that, my assets and my family’s assets are at personal risk.

To help explain the difference, TD Ameritrade conducted a survey after SEC Rule 202(a)(11)-1, commonly known as the Merrill Lynch or Broker/Dealer Exemption rule, was adopted in April 2005. The rule allows stockbrokers to offer services similar to that of RIAs without being held to the fiduciary standard of care and conflict of interest disclosure required of RIAs

In fact, the study done by TD Ameritrade showed that when:

        • 74% of investors did not understand the different obligations required of RIAs and stockbrokers. Unlike stockbrokers, RIAs have an obligation to act in an investor’s best interest in all aspects of the financial relationship.


        • 79% of investors said they would rather work with an investment advisor if they knew advisors provided greater investor protection than stockbrokers.


      • If investors knew that stockbrokers were not required to act in their best interest in all areas of the financial relationship, 70% would not use them

In 2005, the SEC required that brokerage firms offering fee-based advice must make the following disclosure:

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salespersons’ compensation may vary by product and over time.”

After reading the previous disclosure, 79% said that they would be less likely to go to a Wall St brokerage firm for financial advice. Here is a link to the TD Ameritrade study:TD Ameritrade Investor Perception Study

Different Business Models

My business model is very different from the guy down the street at Merrill Lynch. When I started out in this industry 15 years ago, I started as a financial advisor (stockbroker) at Morgan Stanley.

My typical day was spent looking for new clients. Our bosses (who answer to the board, who in turn answer to the shareholders) wanted us to always be adding new clients.

The minimum quota was 10 new clients per month. If we didn’t do this, management gave us a hard time. Even when I was a VP at the firm, this was still required. It was one big sales job.

As a result of this, most brokers recommend to diversify your assets and hold on for the long term. (How do you think that strategy has worked out for their clients since the year 2000?)

Their models are based on risk level and suitability and can quickly be generated by software — this allows the broker to quickly set up an account and move on to the next new client.

In my current role, most of my day is spent crunching numbers. Yes, as a business owner I want to grow my business, but I don’t have any quotas to meet.

If I want to add one or two clients a quarter and spend the rest of my time analyzing the market, nobody is going to come and yell at me.

And if the markets start to get ugly, I can make sure I take care of my clients’ needs first (remember I have a fiduciary responsibility) and not worry about adding new clients just to keep my job.

Active vs Passive Investing

Because the business models are so different, so are the investment strategies. As I mentioned above, most brokers are using asset allocation models for their clients and holding on for the long run — this is passive investing.

Many RIAs are active investment managers. We adapt the portfolios for changing economic and seasonal conditions.

The truth is, active investment managers have had much more success using a systematic-based approach instead of the “set it and forget it” attitude of the 1990s.

Why does it matter?

The last secular bear market that US investors faced occurred in 1968 and lasted until 1982. During that time, buy and hold investors saw a great deal of market volatility, but received little in return for their patience.

john rothe

Make sure you know who you are working with and if their interests are best aligned with yours!

Photo: Eric Ortner


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