One difficulty consumers of financial services face is that all ‘financial planners’ or investment managers look the same, but in truth they can be very different. This article will help you understand a little more about who you are considering hiring and where their interests truly lie. As you will see, the Registered Investment Advisor (RIA) is the only investment entity that doesn’t inherently face conflicts of interest when it comes to managing your money.
People who can manage your investments fall broadly into one of three categories: Wirehouses, Broker-Dealers, and RIAs. You will also find most insurance sales people call themselves Financial Planners, but hopefully you can sniff them out pretty quickly if buying insurance isn’t why you are meeting them.
Wirehouses are the big investment houses you’ve heard of such as Morgan Stanley and Merrill Lynch. They generally make their name and a lot of their money as investment banks. So when Facebook wanted to go public, for example, they hired Morgan Stanley. Wirehouses handle retail accounts for individuals, but that part of the business fits in as a piece of the investment banking puzzle. If a wirehouse is bidding to be the investment bank for a City of Atlanta bond offering, for example, part of the sales pitch is how many retail clients they have that they can sell the bonds to already. If you’ve ever had your money with a wirehouse and wondered why you randomly get phone calls from your person excitedly telling you they have some more wonderful City of Atlanta bonds you should add to your portfolio, now you know why. As an investment bank, they have to move those bonds, and selling them into their retail client base is a big part of how they do it. And yes, they incentivize your buddy the financial advisor to sell the bonds. He gets you to buy one and he gets a commission that you don’t see.
Broker-Dealers are the conduit for commission based products like annuities and front end loaded mutual funds. The people that sell for broker-dealers are called ‘registered representatives,’ and they are allowed to hold themselves out as independent advisors. So they may fly the banner of ‘Bob Smith’s Investments’ or whatever, but they are actually independent contractors for a broker-dealer. The way you sniff them out is they must disclose their broker-dealer affiliation, so look for very small print on their business card or the bottom of their website. You will see language to the effect of “Securities offered through ____”. When you see that fine print, you have found the name of the actual broker-dealer that you are really doing business with.
When commissions are involved, it’s not hard to see the conflict of interest. Annuities can pay 5% to 8% front end commissions. Retail mutual funds can pay as much as 6% front end commissions. That doesn’t make these products necessarily bad, it just makes them expensive and you want to be sure you are buying them from someone who really does have your best interests in mind and isn’t just chasing commissions.
RIAs, or Registered Investment Advisors, are the ‘fee only’ advisors you may have heard about. Most of them came from either the wirehouse or broker-dealer world, eventually tiring of the conflicts of interest and the pressure to sell. An RIA gets paid simply to manage your investments, usually 1% or so of your investable assets annually. An RIA can only make more money from you by making your investments grow, putting you very much on the same side of the table in terms of interests. An RIA has nothing to sell other than their expertise. Unlike the registered representative who pretends to be independent, an RIA is the only truly independent player in the investment management space.
As you might have gathered, the RIA model is the hardest model for someone to make a living off of. There is a lot more money to be made when selling commissioned products, so most RIAs are there because they really do believe the model is the most ethical and fairest for the clients.
There are excellent and very ethical advisors in all three models, of course, but there are a lot more sharks swimming in the wirehouse and broker-dealer waters than those of the RIAs. Annuities are the right answer for some people, and if you are one, you need to work with a broker-dealer representative. Some people really want to be in on the next great IPO or bond offering, and those folks need to work with a wirehouse.
People who want their investments managed fairly and don’t want to worry about whether their advisor is making recommendations based on research and experience or making them based on the commission they carry or the selling agreement they have will prefer an RIA.
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