Investment Cost: Advisor Beware or Investor Beware

State College, PA – “How are you paid” is a common refrain heard by those working in the financial industry. One would think this is a very black and white, yes or no type of question. Unfortunately within the financial services industry, it can be quite a complex answer when you consider the various components involved: advisers, custodians, fund managers, portfolio managers, insurance companies, and Uncle Sam.  So, it would be important that one understands the type of advisor they have and how they are compensated, as well as, ensure the type of advice they are receiving does not have any potential conflict.

There are basically two types of advisors; Registered Investment Advisor Representative (fee-only) or Registered Representative (commissions-only). The Accountability standard and the scope of their advice is the fundamental difference. By the way, the difference in “Accountability” is huge, and could mean the difference between an investor having options or not when encountering sub-par advice. The difference is subtle, but very significant!

A Registered Investment Advisor Representative, under the securities act of 1940; is required to act as a Fiduciary. This explains that your interest (the investor) must be put above their own (the advisor), and they must declare any conflict of interest that may arise.

A Registered Representative is required only to recommend investments that are Suitable for you at the time. They also work primarily for Brokerage firms called B/Ds or Broker Dealers.  In other words, Registered Representatives can legally put their interest above yours when recommending investments Suitable for the situation. In my opinion, most Registered Representatives are ethical and have their clients’ best interest in mind. Inquiring minds would want to know, however, if they are paid by commissions on products…could there be a subtle pressure to do transactions? The reality, unfortunately, B/D firms are usually investment product manufacturers. The B/D firm’s employees, Registered Representatives, are the prime distribution channel to sell their products.

In contrast Registered Investment Advisors are compensated based on an hourly fee, a percent of assets managed, a flat fee, or a retainer.  The Registered Investment Advisor has no incentive to sell any products or do any trading in client accounts. In fact, trading would lead to costs that would reduce the account balances, reducing that compensation.

Over recent years Brokerage employees, have adopted various financial labels without accepting the Fiduciary duty of a Registered Investment Advisor, as described in the securities act of 1940. Rather they adhere to the Suitability doctrine. In fact, this is very common among the very large well-known brokerage firms. Many of these firms and insurance companies have been working with Congress to avoid moving their financial responsibility to a Fiduciary level of accountability.

When answering the question how do you get paid, it depends on the type of arrangement. The more important question one may want to consider asking is what Accountability standard are you held to, a Fiduciary or Suitability standard? The motivation of an advisor may have a direct link to the amount of costs connected to your investments.