In my line of work I get a constant stream of phone calls from three types of people: headhunters, brokers, and financial planners.
The headhunters always ask the same thing. They want to know if I’m happy with my job. They’re a very sweet bunch to be so concerned about me.
The brokers and planners don’t ask about my happiness. They want to talk money. They want to know how much I have in investable assets.
To keep things simple, you can divide financial planners into two categories: fee-only investment advisers and salesmen. Brokers are NOT investment advisers. Brokers are a separate category. More on that in a minute.
Investment Advisers
Investment advisers have passed the Series 65 exam (to be precise, the adviser’s “representatives” have passed the exam), are registered with the SEC or a state regulatory agency, and are legally required to act in the best interests of their clients.
Financial planners other than “fee-only investment advisers” are more like salesmen. They advise you to buy various products, typically insurance and investment products such as mutual funds or annuities. Many are conduits that don’t invest your money directly, but instead farm it out to other advisers or mutual fund companies. That results in another layer of fees.
Other advisers are compensated for each trade they make on your behalf. If you use this kind of adviser, it’s highly likely your account will be churned. “Churning” is when your adviser makes unnecessary trades in your account to generate fees.
Brokers
Brokers are not investment advisers. There is an important regulatory distinction between the two. Brokers are not required under the law to act in the best interests of their client. That’s why a broker who knows nothing about me or my financial situation can cold-call me and promise me a 60% annual return by putting a large portion of my portfolio into covered call options on a single oil refiner (which happened last week).
A good investment adviser would not make that recommendation to me until he understood my financial situation. A good investment adviser would learn about my financial situation and determine an investment strategy that makes sense for me. He is obligated under the law to know my situation and make recommendations that are in my best interests.
A broker is neither required to understand my financial situation nor act in my best interests.
Complicating Things
Now here’s where it gets complicated.
Some investment advisers think they’re salesmen. Rather than act in their clients’ best interests, they try to sell expensive, fee-laden mutual funds to their clients.
Why would they do that? Because the mutual fund compensates them with a kickback. The higher the fee paid by the client, the higher the kickback.
This is not in the best interests of clients because you can stack the research a mile-high showing that fee-laden mutual funds tend to underperform the market. But it’s standard fare for many brokers and investment advisers.
So how can you protect yourself?
Don’t listen to brokers. Their interests are not aligned with yours.
As far as financial planners, use a ”fee-only investment adviser.” A fee-only investment adviser does not receive kickbacks from mutual funds or insurance companies. His advice should be independent and not tainted by his own interests.
That’s great, I never thought about the difference between broker and investment advisor like this ever before. You have distinguished very beautifully. I like it.
You can read more about the distinctions and preferability of using a fee based advisor
Good read
This article nails it. I think you are a little too kind to brokers who work on a commission. These people have scared a lot of investors out of the market.
Invest wisely
Investing is my way of earning money both online and offiline, right now i am into venture capital.;’~
Thanks for the explaination. I have read over the Securities act of 1934 and the Investment Advisor act of 1940 and for the life of me cannot get the diferrence. This was very helpful.
Did you take the covered call option?
Sky Bones:
I haven’t reviewed the ‘34 and ‘40 Acts on this specific issue, but I’m pretty certain they won’t give you the full story. My hunch is that most of the important stuff is found in SEC administrative opinions and rulings.
Sort of an interesting story about the covered call broker. He called at a time I was contemplating leaving my law firm to ramp up a fee-only investment advisory practice (which I have since done). I was interested to hear his sales pitch so I listened.
When he was done with his pitch I told him that it wouldn’t make sense for me. Then we started this strange cycle. He pushes harder, I tell him I get less interested the harder he pushes. He didn’t get the message. He became aggressive and even a little weird. I hung up.
Out of curiosity I bought a small amount of the stock he was pushing (not covered calls, just stock). I use Interactive Brokers and was able to make the purchase at a tiny fraction of the cost he would have charged me.
Within two months the shares lost 50%. They made a nice recovery a few months later and then bounced around the rest of 2009. I sold at a modest loss.
the decision for you to outline their differences is something helpful, as a less number and or none new the difference thank alot.