Advisor vs. Broker

I have come across two articles recently which do a fine job of explaining the difference between a broker and an investment advisor, which is not as simple as it sounds because people in the financial business are allowed to call themselves just about any thing they want without regard to their experience or legal obligations: financial advisor, financial planner, financial consultant, etc. None of these things tells you exactly what the person gets paid to do.

"The Fight Over Who Will Guard Your Nest Egg" by Jason Zweig appeared in the Wall Street Journal at the end of March. Zweig states that brokers are regulated by the Financial Industry Regulatory Authority (FINRA) which is funded by the brokerage business itself. FINRA requires brokers to make investment recommendations that are suitable for clients.

He goes on to say that investment advisers are regulated by the states or the Securities and Exchange Commission (SEC), and are required to act out of 'fiduciary duty' which obligate the advisor to put the clients' best interests first.

What's the difference? Assume that an S&P 500 index fund is appropriate for a client. A broker could recommend one that has a 0.75% expense ratio that pays a 0.60% annual commission, and not tell the client that an identical fund is available which only has a 0.30% expense ratio but only pays a 0.15% commission. The more expensive fund isn't unsuitable, it's just not in the best interests of the client (but it's a great deal for the broker!). An advisor, as a fiduciary, is required to act in clients' best interests and disclose any conflicts of interest.

The rest of Zweig's short article is worth reading.

"Pick Your Financial Planner Carefully" by Humberto Cruz answers a reader's question about how to check up on a planner's recommendations. Cruz makes some of the same points as Zweig, adding that a Certified Financial Planner as well as Registered Investment Advisor is required to act in a fiduciary capacity.

He also point out that brokers, known as 'registered representatives', are employees of their brokerage firms and have a contractual duty to those firms, not their clients. He states that a broker's contract with his firm may require him to recommend a higher-cost fund to protect the firms revenues, as long as that fund is not unsuitable for the client.

In the closing paragraph Cruz writes "If you are OK with your planner not being a fiduciary - I wouldn't be - at least ask him to explain precisely the reasons for his recommendations, including what's in them for him." Another short but very good read.

Part of the new legislation in Washington DC involves the regulation of providers of financial services for consumers. If you think that financial advisors, planners and consultants of all ilk should be required to put customers' interests first, let your Senators and Representative know. If you want more information, contact our office. We have some sample paragraphs which outline these issues from a consumer standpoint. You can use these as you see fit - it will only take ten minutes to write a personal letter and exercise your right to representation in government.