• Erik Baskin

The Difference Between a Broker and a Fee-Only Financial Advisor



Background on the Industry

The terms "financial advisor, financial planner, and wealth manager" are used by financial professionals from very different backgrounds that do very different things for clients. The requirements to operate as a financial professional are very low when compared to other professional fields such as CPAs, Lawyers, and Doctors. The problem with this is that you don't know how someone is compensated or how they operate when they say that they are a financial advisor. Based on the way that the financial professional is registered, this can mean very different things for how they are compensated, the value that they provide to you, and potential conflicts of interest.

2 Types of Registrations

There are two ways to be registered as a financial professional with the regulatory bodies of FINRA and the SEC:

  • Broker: This is someone who sells and buys products or investments to clients. They sell different types of securities, annuities, or insurance and may receive compensation for these sales.

  • Investment Advisor: This is someone who gives financial advice for a fee. They do not sell a product or earn a commission on their advice. If somebody is solely registered as an investment advisor, this is what is known as "fee-only".

Most of the over 300,000 financial professionals in the United States are registered as brokers. These are typically your advisors that work for the big firms that you may have heard of such as Northwestern Mutual, Edward Jones, Morgan Stanley, and Fidelity. Some of these professionals are even dually registered as both a broker and investment advisor. This means that they can pick and choose which hat they want to wear and when they want to wear it. This is how they can charge you a fee for financial planning or an Assets Under Management (AUM) fee for investment management, but at the same time earn a commission on the products that they place you in or sell to you. An example of this would be if you had $1 Million in investable assets, and your advisor charges a 1% AUM fee. You will pay $10,000 per year for investment advice, and your advisor is wearing his or her investment advisor hat. At the same time, this advisor can place you into mutual funds that are produced by the company they work for and they earn a commission on that placement. An example of this would be a mutual fund with a front-end sales load of 1.5%. This means that you pay 1.5% of your assets as a fee to just invest in the fund, and your advisor will receive a cut of that as a commission for placing you into that fund. Now your advisor is wearing his or her broker hat where they can receive commissions on products that they place you into. Another example would be a whole life insurance policy that they recommend to you. This is extremely common with Northwestern Mutual in particular as that is their main product. This is a product that is probably unsuitable for 99% of the population, but it is riddled with fees and is extremely lucrative for the company that sells it.

Check Your Financial Professional

Here is a link to a tool that you can use to look up any financial professional to see exactly how they are registered: https://brokercheck.finra.org


What to Look For and Consider

When you are looking for a financial advisor, you should be looking for someone who is solely registered as an investment advisor and is thereby a fee-only advisor. A good way to find these advisors are sites such as Fee Only Network, NAPFA, and XYPN. These types of advisors can only be compensated directly by you for their financial advice, and cannot legally receive a commission or compensation for any products or strategies that they recommend. This makes this advisor a fiduciary, which is just a fancy word that means the advisor is legally and ethically obligated to act in your best interest at all times. Of the over $300,000 financial advisors in the United States, likely less than 10% of them are fiduciaries. You will typically find these advisors working for smaller or more boutique wealth management firms, and not the big names that you may see in the commercials such as Northwestern Mutual, Fidelity, Morgan Stanley, and Edward Jones. The other advantage about working with an advisor that does not work for one of the large firms is that he or she can typically go deeper into your financial life and offer more of a white-glove service than a large corporation can due to the compliance oversight and regulatory requirements that typically restrict them. When working with an advisor that works for a large brokerage firm, you are more likely to have a transactional relationship that is product-based. This may involve discussions that are focused on life insurance or specific mutual funds. When you are working with a fee-only, fiduciary financial planner, you are more likely to have discussions around your goals and values and a broad array of financial planning topics such as cash flow, insurance, tax, investment, retirement, and estate planning.


Conclusion

One thing that that the above discussion does not account for is the integrity of the person that you are working with. Whether they are a broker, or a fiduciary registered as a fee-only investment advisor, financial professionals need to operate with integrity. There are plenty of bad actors that are registered with every single financial designation. So although I make the case that a fee-only advisor is the way to go for most families, this does not assure that the financial professional is a competent and honest individual, and likewise does not mean that all brokers are less competent or less honest.


I hope that this was a good overview of the little-known differences between types of financial professionals, how they are compensated and registered, and what things you should be looking for when you are hiring or working with a financial advisor.