To ensure that you receive the most unbiased financial planning and investment advice, be sure to engage only an independent, RIA-licensed, fee-only financial advisor. To help you understand why this is so important, we’ll discuss the evolutionary process that brought them into existence.
In the Beginning, There Were Stock Brokers
We’ve all come to shudder, at least a little, when we hear the phrase, “stock broker”. It’s not unlike our reaction to hearing “used car salesman”. How did this come about?
Stock brokers work as sales representatives for banks and large financial brokerage firms. A stock broker does not work for you. Each will have passed at least one securities exam. Their formal title is actually “Registered Representative” and they are compensated by earning commissions and other incentives based on the products they sell to you.
Stock Brokers Earn Commissions Selling Products
In their role as stock broker they have two primary responsibilities. First, to earn themselves as much money as possible via commissions and other incentives, and, second, to earn their employer as much money as possible, by selling products their employer has instructed them to sell as a priority. Given the choice of offering you a highly profitable product to themselves and their employer, or a low profit product, which do you think they’ll choose? We all know the outcome of that decision because we have all been witness to the financial atrocities of the past several decades.
Clearly, there’s a significant conflict of interest present. You want the lowest cost, highest performing investments in your portfolio. The stock broker and their employer want to sell you the most expensive products, perhaps regardless of performance and risk.
But Aren’t They all Now “Financial Advisors”?
So, you’re thinking, “but at the big brokerage firm I spoke with, they now only employ financial advisors?” Or, maybe it was the local bank who introduced their representative as a financial advisor. Well, it turns out that there’s no rule regulating who can and who can’t call themselves a “Financial Advisor”, or “Financial Planner”.
What we’ve seen, then, running in parallel with the authentic movement toward non-commissioned, fee-only advisors (discussed below), is a movement within the banks and large brokerage firms to simply refer to their stock brokers as “financial advisors” and “financial planners”. Nothing else has changed. They are still only licensed as registered representatives and they are still paid by earning commissions and other incentives. And they still do not work for you!
Enter the Advice Giver, the Fee-Only Registered Investment Advisor (RIA)
A new role emerged from the financial chaos of the past several decades, that of Registered Investment Advisor (RIA). An RIA, unlike a stock broker (including stock brokers who call themselves financial advisors), works for you! And this isn’t a fancy marketing phrase. An RIA is legally bound to serve you as a fiduciary, meaning they must act at all times in your best interest.
How Fee-Only Compensation Aligns Advisor and Client Needs
You might think, “well, ‘Fiduciary’ is a fancy word, but where’s the real difference?” The real difference is in the way an RIA is (and is not) compensated. A RIA-licensed financial advisor or financial planner earns no commissions on investment transactions made on your behalf. Further, an RIA exists independently from banks and large brokerage firms and is in no way influenced by them when offering investment advice. The combination of these two changes alone goes a long way toward eliminating the huge conflict of interest that has plagued the industry for 100 years.
RIAs must still be compensated and this is where the Fee-Only (sometimes called Fee-Based) method of compensation comes in. An RIA-licensed financial advisor may charge a few different ways, depending on what services are needed.
Typically, the RIA is hired to create a financial plan and then to manage an investment portfolio. Under this scenario, the fee-only method of compensation will be charged as a percentage of total assets under management (usually in the range of 1% to 2% annually). Under this arrangement it is not uncommon for the advisor to provide the financial plan at no charge, including annual reviews and revisions of the plan. The beauty in the fee-only compensation arrangement is that if the advisor wants to earn more money, they must grow the value of your assets! Your needs and the needs of your advisor are in alignment.
In the event that the client only wants a financial plan or to receive some investment advice, the advisor will likely charge either a fixed fee or an hourly rate fee. Either way, in all cases, the fee is known and disclosed up front. There is complete transparency.
The RIA Financial Advisor Sees the Whole Picture
There are many differences beyond compensation methods between RIA-licensed financial advisors and stock brokers who call themselves financial advisors. For example, most RIAs own their own business. Many RIAs actually started out as stock brokers and decided to go through the rigorous RIA certification process to be able to work apart from what they saw as unethical business practices at their prior place of business.
One big difference between the two is that an RIA is mostly concerned with the big picture of your life and that of your family. This is why they almost always offer comprehensive financial planning services. They understand that your investment portfolio exists to support your goals in life. They want to know what these goals are and to help you plan to achieve them. They’re looking for a long-term, prosperous relationship. Even an ethical stock broker will still mostly concern themselves with choosing good investments to sell you, but won’t know if these investments are the best selection to support you on the road to achieving your goals in life.
The best way to know what “fee-only” is, is to know what it’s not. “Fee-Only” means “no commissions”. It means that fees are disclosed and transparent. The fees are usually charged at an hourly rate or on a fixed-fee for small projects, or as a small percentage of the value of assets under management for long-term relationships. As such, the goals of the financial advisor and client are in alignment and conflicts of interest removed.