If the financial industry seems confusing, it’s because it’s made to be on purpose! It’s the combination of complex, structured products and endless amounts of legal regulations and disclosures that they know people never read. It’s so daunting it can make your head spin!
I understand how complicated the financial industry is for everyone not in the industry. The most concerning thing I notice when meeting with prospective clients is how little they understand about their current investment arrangement. By that I mean they don’t know what the agreement with their professional is, how he/she is compensated, what the total fees and expenses of their investment plan are, what they’re actually invested in and why they own it.
So here’s a quick rundown to help you better understand the possible arrangements out there so you can make an educated decision as to which is right for you:
- Do it yourself or work with a professional. If you feel confident in handling your investments on your own and have the knowledge/experience to do it right, by all means, this is the easiest and cheapest way to go. A lot of people enjoy handling it themselves and will check-in with an Investment Advisor maybe once a year for a quick “look over shoulder” for new ideas and to make sure they’re not doing something foolish. And be honest with yourself, taking “tips” from other people or picking the funds that have “done the best over the past few years” is not managing it properly…
- If you would rather work with a professional, you basically have two choices: Broker or Investment Advisor. There is a HUGE difference between the two and this is a big area of confusion for many investors. Many people often refer to their professional as their “advisor” or their “broker” without knowing the difference or knowing how their professional is actually acting. So, let’s discuss the differences:
-Broker: A broker makes sense if you want to be calling the shots. A broker is a licensed professional that works for a commission. They will make recommendations and place trades for your account at time of purchase. After that, they have no responsibility to watch your investments, make sure it’s still a good idea to own them, or most importantly, make sure they’re still appropriate for you. Perhaps the biggest mistake I see people making is relying on their broker to “watch” their money when this just isn’t what they’re paid to do.
As I mentioned, a broker makes the most sense when you as the investor want to be calling the shots or want a hands off, passive approach to investing. If you said “I love XYZ company because I love their product and want to invest in their stock with no intention of selling it as long as I think they’re product rocks…” then you would call up a broker and instruct them to purchase XYZ stock for your account. After that, it’s up to you to follow XYZ company/stock and decide when to sell it.
It also makes sense to work with a broker when you’re starting out with investing and have a relatively small portfolio. In this instance, most people start with mutual funds because it allows them to diversify their money between anywhere from 50 to a couple hundred stocks or bonds in one fund – which is very difficult and costly to do if you tried to buy that many securities individually. Here, an investor is taking a long-term view and allowing the mutual fund manager to manage their money/investments until their portfolio is large enough that they’re able to properly diversify on their own.
It’s very important to understand what type of mutual fund/s your broker may be recommending. They should walk you through the different types of share classes and fully explain how the expenses work and how they’re compensated from it. This is one area that I see a ton of brokers try to hide behind by using fees that are embedded in the fund so the client is unaware of how much they’re actually paying. When people come to me and say they’re frustrated that their money is not growing, this is often a big reason why.
-Investment Advisor: An Investment Advisor is someone who works under a fee-based relationship and does not accept commissions. They act as a fiduciary for their clients, meaning all recommendations and actions are in the best interest of the client, and manage their investments with a prudent standard of care.
Working with an Investment Advisor makes sense if you’re looking for financial guidance (typically through some sort of financial plan) without having to worry that the recommendation is going to be to buy some product that the professional sells and earns a commission off of. Meaning, don’t go to a broker if you want a financial plan that you can have the confidence is in your best interests.
As for your portfolio, it makes sense to hire an Investment Advisor to manage your investments when you want them managed. This means a diversified portfolio created to reach your goals based on the guidelines you set. You allow the advisor to do his/her job because you have the confidence of knowing that any change made is in your best interests. For part of your portfolio, they might actually pick the individual stocks/bonds on their own, and for other parts they might make the recommendation to hire another professional – some type of fund manager with a specialty in managing that specific asset class. You also know that they’re not just churning the portfolio to generate trades because they don’t work for commission.
Some professionals act as a broker only, an Investment Advisor only, or are dually registered, meaning they can act under either arrangement. A dually registered broker/advisor can be convenient for the client because you can start out under the broker arrangement until your portfolio is large enough to manage as a fiduciary Investment Advisor. They also work as a fiduciary for a lot of their clients and that standard of care tends to blend into their recommendations, even when working as a broker. Just make sure they’re not trying to rip you off though by saying that you can trust them because they’re dually registered when their goal is to sell you a bunch of products… I used to be dually registered but now only act as a fiduciary Investment Advisor because I believe it’s best for the client to eliminate any potential conflicts of interest. This means that I can’t work with everyone, but I’m fine with that; I don’t want to. I want to help those people who it makes sense to help, that I’m a good fit for, and that are looking for a fiduciary advisor to trust.
It boils down to understanding the difference between how the professional works, how they’re compensated, and what they’re and your responsibilities are. Unless you as the client want a big say in making the decisions, I would not work with a broker because it puts too much responsibility on your shoulders. They’re not liable if things go terribly wrong and the advice is not always objective. This is not to say that there aren’t good, honest brokers out there, because there are and I know a lot personally, but there are also a lot of sleaze-balls who act like they care but really only care about selling you some product that pays them a juicy commission with no intention of ever talking to you again.
So, if you would rather work with a professional than handle things on your own, make sure you find the right arrangement for your needs and don’t be shy about asking a lot of questions. After all, this is your hard-earned money…
Please feel welcome to contact me if you have questions regarding this topic. Thanks for following!
-Nick