Should I choose an investment adviser or financial adviser? Unfortunately, the designations sound quite similar, leaving many investors without a clear understanding of their function and responsibilities. In this post, we try to shed some light on this.
We find most of the relevant terms defined in the federal Investment Advisers Act of 1940. The Uniform Securities Act, which is the model legislation most states use for drafting state securities laws, uses the same words.
Let’s start by reviewing the definitions of various terms.
In legal terms, a broker means any person engaged in the business of effecting transactions in securities for the account of others. Further, a dealer describes any person regularly engaged in the business of buying and selling securities as principal for his account.
In layman’s terms, broker-dealers are salespeople. Similar to sales staff in any non-financial industry, we compensate broker-dealers through commissions or markups they receive for effecting transactions.
There is no legal definition for the term financial adviser; anyone can call himself such. That is why we see this term often used to stay vague about the nature of the services provided.
Even informed investors tend to view financial advisors similarly to investment advisers, and in a more positive light than broker-dealers. For this reason, broker-dealers often like to refer to themselves as financial advisers.
In contrast, the term investment adviser has a precise definition. We identify these persons by meeting a 3-prong test. By law, an investment adviser is anyone who:
- provides investment advice, reports, or analyses with respect to securities;
- is in the business of providing advice or analyses; and
- receives compensation, directly or indirectly, for these services.
In layman’s terms, investment advisers are consultants, paid for providing investment advice, and held to the fiduciary standard.
A fiduciary is a person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets for the benefit of the other person rather than for his or her profits and must exercise a standard of care imposed by law.
Besides their fiduciary duty, investment advisers have to meet numerous further requirements regarding their fee structure, ethical standards, record keeping, and more. That’s why it seems more attractive to some professionals to appear as an investment adviser, than actually being one.
To further complicate things, many financial professionals choose to use a dual registration: they are acting as broker-dealers and investment advisers simultaneously. Doing so makes sense in some situations, but potentially also blurs the line between the two, leaving clients unclear about the obligations of their counterparts.
We have seen brochures offering clients multiple plans side-by-side and seemingly interchangeable:
- plans charging commissions per trade, but no fees
- plans charging a fee for assets under management, but no trade commissions
The fee structure has important implications: one plan is with a broker-dealer, while the other is with an investment adviser. Salesperson versus consultant: They are far from being the same, and investors should make a conscious decision.
Why should you care?
In working with an investment adviser, you can rest assured to receive advice in your very best interest. Further, investment advisers are required to disclose their potential conflicts of interest, especially compensation and benefits received from 3rd parties.
In contrast to investment advisers, we hold broker-dealers to a much lower standard. Their only obligation is to ensure the general suitability of the products recommended to a client. This is not to say that broker-dealers cannot provide valuable advice. Unfortunately, for a client, it is impossible to determine the real motivation behind the advice: is it attractive commissions, or a genuine interest in providing sound advice?
Successful investing is at the core of our retirement planning, and with that among the most critical decisions, we make in our lives. Therefore, we should seek advice from those we can trust to act in our best interest. In our opinion, building trust starts with using unambiguous designations for the services provided.
At Bertram Solutions, we take our fiduciary duty very seriously. We have decided against any affiliation with broker-dealers, to avoid this possible conflict of interest.