This is a guest post by Kenneth G. Winans, a veteran investment manager based in Novato, Calif.
Despite what you might read elsewhere about managing your own finances, it is often a good idea to get some help. It's for roughly the same reason you hire an attorney. You don't have the skills to handle a divorce or a property dispute.
First, though, you need to understand a little bit about the mind-bending terminology Wall Street uses to describe those who want to help you enlarge your nest egg. This basically comes down to two words: advisor and broker.
An advisor is a professional you hire to pick stocks, bonds, real estate investment trusts and other investments for you. Advisors are "fiduciaries," which means they're legally obliged to act in your best interest. They usually charge a flat salary or fee or receive a cut (1 percent is typical) of the assets under management. Because of the compensation structure, advisors are seen as having fewer conflicts of interest than brokers.
Broker is short for stockbroker—someone working for an investment firm whose job it is to persuade a client to buy or sell stocks, bonds, mutual funds, ETFs and other financial products. Brokers are salesmen, and they're paid on commission: no transaction, no pay. So there's considerable incentive for them to gin up business. And they're not fiduciaries. The broker's standard is "suitability." That means the investment should be appropriate for a client, but doesn't have to be the best or even conflict-free.
"In their ads, the brokerages sell themselves again and again as providing comprehensive financial planning," says Scott Ilgenfritz, a Florida securities lawyer and past president of the Public Investors Arbitration Bar Association, an advocacy group that helps public investors in securities arbitrations. "They send the message: You'll be safe with us—right up until you have the audacity to complain. Suddenly, it's: `We're not advisors, we're just order takers.'"
The distinction between advisor and broker used to be reasonably clear. But traditional brokerage revenues turned out to be vulnerable to competitive pressure from discount investment firms, no-load mutual funds and exchange-traded funds, and the advent of the Internet. And in the 1990s, the major brokerages stopped calling their salespeople "brokers" and started calling them—surprise!—"advisors."
This triggered a decade-and-a-half-long fight, brought by traditional investment advisors who argued these renamed brokers were deceiving the public into thinking they were money-managing fiduciaries. The brokerages responded that they were better policed, by the Financial Industry Regulatory Agency (FINRA), than traditional advisors, who, depending on size, were regulated by either the U.S. Securities and Exchange Commission or state securities departments.
At first, the SEC passed "rule 202," which sided with brokerages, allowing brokers earning commissions to also call themselves financial advisors and charge advisor-type fees in exchange for guidance without registering with the SEC as investment advisors or living up to tougher fiduciary standards. But advisors sued and, in 2007, won. The rule had "created an unlevel playing field," says Duane Thompson, a senior policy analyst with Fi360, a fiduciary-standards advocacy and education firm based in Bridgeville, Pa.
Alas, the SEC still offered brokerages exemptions that allowed them to call their brokers "advisors" and charge fees based on the size of a client's brokerage accounts, as long as they met some more stringent disclosure standards.
The Obama administration has called for changes to SEC rules that would force anyone called an advisor to adhere to the tougher fiduciary standard. But with the Dodd-Frank Act in 2010, Congress left the decision up to the SEC. The SEC has studied the issue and asked for public comment, but hasn't ruled on the matter since the comment period ended in early June. And last month, when President Obama pressed regulators to tighten financial-industry rules to avoid a repeat of the 2008 economic crisis, he didn't deal specifically with the advisor-broker controversy.
Until the SEC makes its next move, who is stuck in the middle of all this? You, especially if you don't want to overpay for good investment guidance.
I happen to be a long-time financial advisor who started his career working for big brokerages. Here's my take on this:
If you take full responsibility for your investments and really just need somebody to carry out your orders and handle basic administrative tasks, then a salesman—a broker or broker-type advisor—is probably all you need. FINRA provides some good tools to help you pick one. To check out the background of any broker, including complaints and disciplinary matters, go here.
