When dealing with a financial adviser, there are certain things to look for with one issue taking absolute precedence!
The Fiduciary
That issue taking absolute precedence, is to consider whether your adviser is a fiduciary and legally required to do what’s in your best interest.
That issue taking absolute precedence, is to consider whether your adviser is a fiduciary and legally required to do what’s in your best interest. Registered Investment Adviser Firms (RIA’s), and Investment Adviser Representatives (IAR’s), those who represent an RIA, conduct their business based on a “fiduciary” standard.
RIA’s and IAR’s operate under a “fiduciary” standard as required in the financial services industry under the legal definition. This means that they are required to do what’s in a client’s best interest, and not in the best interest of themselves – ALWAYS. These advisers, like us, are licensed with the Securities and Exchange Commission (SEC). Also, the SEC introduced Reg BI, which has now become effective as of June 1st, 2020. Click here to read our article titled: What Regulation Best Interest (BI) means to you. More information on Reg BI can be viewed here.
So what about a broker-dealer?
Broker-dealers (BD’s) however, operate a little differently, which means they must act in a “suitability” standard. BD’s are licensed with the Financial Industry Regulatory Authority, also known as FINRA. So what does a “suitability” standard mean exactly? Brokers represent dealers, whose interests they serve. Since they follow a “suitability” standard, that means only the recommendation must be suitable for a client’s needs at the time of the recommendation. This standard does not require the advice to be in the client’s best interest. Confused yet? Here’s an example: This is a story of nonfiction. No names have been changed, no characters invented, and some events may have been fabricated for humor, but I digress…this happens all the time.
Let’s just say I need a new car. I walk into a new car dealership with sucker stamped onto my forehead. Remember, I said this was an example. A salesman comes up to me and asks if I’ve been helped? I say no, and begin to tell him all the options I’m looking for in my next car. It’s obvious to the salesman that I described a competitor’s vehicle. As you know, car salesmen know their industry well and for this very reason! In this particular example, I’m not a car guy. All I know is a car has four wheels, needs the headlight fluid topped off on occasion, and that’s about the extent of my automotive knowledge for this character. So, the salesman points me to one of his vehicles on the lot that is more expensive than the competitor’s vehicle, but will meet my needs with some varying differences. Most of these differences I won’t notice until later. Again, for this example I’m not a car guy and just have the word — well, you know — stamped on my forehead. So, I inspect the car with the salesman while he’s pointing out all of the frills and thrills. I decide to buy it and sign all the paperwork. As I drive away with a grin from ear to ear, I wave to my new best friend and the sales manager I also just met. Really nice and trustworthy guys these two. Remember the forehead of my character? Both of them are smiling too since they just earned a commission for selling me that car! Is the car suitable for me? Probably. But, instead of referring me to the dealer that actually sold the car with exactly every single option I wanted and at a cheaper price, he sold me a car from his inventory that was much different. Was the salesman acting in my best interest? Not at all! He was acting in his best interest and also his dealer’s best interest. He could have easily said to me that the vehicle I described was built by another manufacturer being sold down the street, and pointed me in that direction. And let’s say another unfortunate mess happened in this example. Lets assume the engine blew up, transmission had continual issues, headlight fluid indicators were missing, etc. etc.; unfortunately, then it’s too late and I was taken for a ride! Can this happen to an investor who is not well versed in the financial arena? Absolutely!
Brokers, who are agents for dealers, earn commissions on the products they sell. Again, brokers represent a dealer whose interests they serve, not a client’s. So, in the broker-dealer world, some products pay better commissions than others. Let’s say a broker wishes to sell you their dealer’s costliest commissioned proprietary product because — well — he just thinks it’s a superior product compared to the less expensive ones. The dealer also requires their brokers to meet sales quotas on dealer proprietary products, typically on an annual basis. Look, don’t ask that’s just the way it is. There is no need to show you the inferior, cheaper products, because in his eyes — well — it’s just inferior. That’s all you you need to know. Like the story I shared with you previously, car dealerships operate much the same way. Does this sound like an ideal situation for you? Probably not.
The Hybrid Adviser
However, this type of adviser doesn’t necessarily mean that he will always operate in a fiduciary capacity!
There are also hybrid advisers, those that work as a broker and an IAR. That means, they will conduct business on a commission and fee based compensation structure. They are licensed by FINRA and the SEC, simultaneously. These advisers may offer many products and services and can also offer a client a choice in how they wish to be charged. However, this type of adviser doesn’t necessarily mean that he will always operate in a fiduciary capacity! Typically, many of these hybrid advisers will operate as a broker with a client that may not be well versed in the financial services industry, then switch hats and operate as an IAR with clients that may be well versed. How does he know when to switch hats? Well, most of the time he will make that decision and that’s really all you need to know. Starting to make sense now?
The Registered Investment Adviser
…and the angels began to sing… RIA’s and IAR’s earn a fee on the products they sell, not commissions. RIA’s don’t care (well, they care just not from a compensation standpoint) which security products you purchase because they are getting paid the same fee regardless. The fee you pay your adviser may be on a recurring monthly or quarterly basis (the fee schedule). This fee schedule is negotiated and typically stated in the firms advisory management agreement at the time of engagement for financial services. Does this sound like a more ideal situation for you? Probably, a resounding yes!
So, let’s recap
Really, the only way to ensure that the recommendations you receive are totally 100% unbiased, is to work with an RIA and/or IAR.
In order to choose the proper financial professional (broker-dealer) or investment adviser (RIA), ask yourself these questions:
1. Do you want objective investment advice based solely on your individual situation 100% of the time? Or, do you want the investment advice you receive, to be influenced by how much money the financial professional will make based on the recommendation?
2. Do you want to work with a hybrid adviser who may change hats when necessary? Or do you want to work with an adviser that will wear one hat and always place your interests ahead of their own?
3. Do you trust your spouse? Now, this may be a loaded question for some but honestly, doesn’t any relationship flourish and become more resilient with trust? Your financial Investment Adviser is no exception to that rule.
4. Regulation Best Interest (BI) is now effective as of June 1st, 2020. Click here for further information.
So here’s the truth, because that’s why you came here..right? The only way to ensure that the recommendations you receive are completely 100% unbiased, is to work with an RIA and/or IAR. These folks will work for their clients’ needs and in a fiduciary capacity – ALWAYS. There are no hats to switch when it’s convenient for them and your needs will ALWAYS take precedence over theirs, not their compensation. This is all that we do!
The bottom line is this: Forget about the broker-dealer having your best interest at heart. That’s not to say they aren’t out there, but they are far and few between! A hybrid Investment Adviser should also be dealt with caution. Your best bet is to work with an RIA and/or IAR, who will operate in a fiduciary capacity at all times by placing your needs ahead of their own! Contact us for more information.
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Posted from Admin at Association Financial Services, LLC
