The financial industry is inundated with experts who call themselves financial advisers or financial planners. Those are merely general terms or job titles, which is why so many potential investors who are shopping for financial services are easily confused by the products and services offered.
Let’s take a look at the two most popular business models, fee-based Registered Investment Advisers (RIAs) and broker-dealers. Broker-dealers are often big corporations, like Merrill Lynch and Morgan Stanley who have a national presence. Brokers are employees of a parent firm, and they typically rely on their parent company for product recommendations or portfolio construction. This was a popular model in the 1980s and early 1990s, when you had a “hot stock tip” and you’d call your broker to make a quick buck in the market. More often than not, the broker called the client with the “hot tip” and executed the trades with the investors’ permission.
RIAs work a bit differently, as they manage client relationships from a holistic perspective across multiple financial topics. Most often, services are based on the financial plan they develop for the client. It is the plan that is custom to the client’s financial situation that dictates the amount of risk the client should be taking based off time horizons, cash flow and goals and how their assets should be allocated. RIAs adhere to a fiduciary duty to the client, which means the investment recommendations and financial advice must be in the best interest of the investor.
Broker-dealers, on the other hand, generally adhere to a suitability standard, meaning the investment must be in line with the investors’ goals, but it may not be the most affordable investment based on fees. Often, brokers sell investments that are being serviced by the parent company. For example, a broker may suggest a client purchase shares of a particular mutual fund that is managed by the broker’s parent company. In turn, that broker may receive a commission for selling shares of that fund. In contrast, an RIA may suggest investing in either the same fund or a substantially similar fund that has lower fees and costs. The RIA receives no commission from the purchase.
This leads us to how the investor pays for the services provided. Ideally, investors should want the highest quality investments with the lowest fees. Broker-dealers are typically paid on commission, so every time they recommend a trade in your portfolio, the broker is getting paid. Some may offer unlimited trades but charge you a percentage on your assets that he manages. For example, a broker may charge you 1% on your total portfolio balance, but he may also receive a commission for selling the parent company’s funds or products. Funds carry fees that are charged to the investor. While the broker’s parent company’s funds may be high quality, the fees may not be the lowest.
The potential for this conflict of interest has been an inherent problem with the broker-dealer model, which was the impetus for the Department of Labor’s fiduciary rule that is scheduled to be phased in beginning in April 2017. It would require broker-dealers to adhere to a fiduciary standard when working with retirement assets. Brokers could still use a suitability standard for brokerage accounts. Furthermore, President Trump has issued a memorandum that may delay the rule’s implementation and require the Department of Labor to further look into the rule’s impact on the industry.
Registered investment advisers also charge fees based on a percentage of assets under management, often around 1.25% of assets, but also with a sliding scale. The more assets under management, the lower fee the adviser may charge. Fee-based RIAs do not receive commissions. With an RIA, a client’s assets are held at a custodian, and the custodian may charge for trades placed. But because the RIA is only receiving a percentage based on your assets, it is in their best interest to put the investor in high quality investments with the intent to hold for the long term. The fiduciary responsibility the RIA has to a client ensures that the RIA is placing the client in investments that they believe will grow the client’s assets while minimizing risk. RIAs can also charge by hourly fee for a specific service or by flat fee for a specific project.
When shopping for services it is important to know that the fees charged by the financial professional cannot always be compared apples-to-apples. As part of your due diligence when seeking financial guidance, you need to ask how you are paying for the services they provide you, and if the professional is paid based on your investment choices.
If you have questions regarding how your investment fees can affect your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
