Brokerage accounts have been the normal way of investing in this country for many years. A complicated question that I get asked often is - What is the difference between an Investment Advisor's way of doing business and a broker's way of doing business. There are many differences but also some similarities that make the whole issue confusing to most people. I was confused at first too. I started out as a broker and then move my business over to the advisory model. Let's take a look at the different traits of each way of doing business.
A traditional brokerage account is where most people begin their investment portfolios. A brokerage account offers easy access and is simple to operate. Think of the brokerage account like your checking or savings at the bank except no FDIC insurance coverage. You put money in, invest the money in something, and hope that your investment does well.
Your broker will you make decisions or in reality you don't even need the broker to have a brokerage account. They are offered online for deep discounts on the commissions for placing trades. The broker can be a huge help in deciding what to invest in. Typically, the broker's firm has a research team that recommends certain stocks and bonds that might be good investments. The broker then passes the information along to you so that you can make the final decision.
Broker's charge a commission most of the time for each trade placed or each buy or sell order you give them the go ahead on. They can charge an asset management fee but it is often removed from their actual business. If a broker offers an asset fee arrangement, your money is sent to a money manager that invests the money for them. They usually have little or no decision making authority of what the money is invested in. The problem with this idea comes in the form of what your broker's responsibility is to you, the client.
This brings us to one major difference between a broker and an Investment Advisor. The difference is in the word Fiduciary. It basically means to act in the best interest of or to treat the money as if it were our own. What it means to a client is this: Investment Advisors must, by law, act in a client's best interest not matter what the circumstance. Brokers do not have this responsibility. Their requirement is to check the suitability of an investment only, not to act in a client's best interest. For example, a conservative mutual fund might be suitable for most people. But if you already have half of your assets in the same kind of investment then it is not in your best interest to invest more money into that area. I see this kind of work from brokers a lot. Why? This question leads us to another major difference.
Commissions versus annual asset fees have been an argument in the financial world ever since I got involved in the business in 1999. There have been heated debates between traditional brokers and innovative Investment Advisors trying to change the way that business is conducted. Here is a breakdown of each side's opinions.
Commissions in any field lead to a certain amount of conflicting interest. If a broker is selling a stock that generates a $700 commission then who are they really helping? Is it the investor or the broker's agenda that is being followed? It is really impossible to know and that goes for all sales where commissions are involved. Investment Advisors charge annual asset fees. This deletes the argument of commissions. For example, your Investment Advisor calls and wants to make you aware of a change that needed to made to your account. A mutual fund was moved from one Fund Company to another, it generated no commissions or fees. One fund was looking better than the other so the change was made. Yes, there is an annual fee on the account but no transaction fees. Do they have your best interest in mind? Contrasted with, your broker calls and wants to make the same change to your account. A $3,500 commission is generated with the purchase. Does your broker have your best interest in mind? Maybe they do. You might have one of the truly exceptional brokers working for you but it is impossible to tell for sure.
The next difference is the level of service and ongoing maintenance that you receive in regards to your account. Do you want to you have your money constantly watched and changes made as needed? Or do you want to have your account occasionally monitored? A sad fact is that most brokers only look at your assets if you call them and ask questions or if you are going in for an appointment. There might be brokers out there upset with me but come on fess up! It is true that your broker might review your account before calling and pitching a new product to you. Do they have your best interests or commissions in mind? You decide.
With an Investment Advisor, typically they watch your accounts very closely. Their income is directly based on how well your money is performing. If your investments go up, so does their income, if your investments go down, so does their income. So any investment advice to make changes is very likely to be in your best interest and theirs. So is an Investment Advisor watching your account closely? You bet they are!
To be fair, there are some arguments that are valid against the Fee Based idea. One is your asset type. For example, if you have all stocks that you never trade or sell for income then it would be ridiculous to add a fee to your account. The fee would just take money away and not add any value at all. Some brokerage accounts are designed this way or have been built up like this over long periods of time. The other argument is that the Investment Advisor might be a little more aggressive to try to increase their fee income. I would have agreed with this until the market started performing poorly. No broker or Investment Advisor wants to lose money for clients. Most clients would rather not lose money as well. I would rather perform a little under everyone else in the up markets and not lose money when the market goes down. Doing the math makes that scenario about equal in performance.
One more major difference is how the assets are actually managed. At a brokerage firm, your account is managed by your broker with oversight from a manager. The manager might have 20,000 accounts to look at so in reality your account is managed by your broker. The manager really comes into play when a broker is making really bad investment choices or using investments that are not recommended by the firm. You give your money to the broker, he makes recommendations usually based on his firms recommendations, then you decide what to invest in. To be completely honest, having been there and operated in that exact manner, that is a sales position. Be careful and research each idea. Brokers are good salespeople, sometimes the best!
At an Investment Advisory Firm the money is managed differently. The advisor must get a detailed view of your financial situation. From that point they may differ. They might charge a fee for the advice they give. They are more likely to make a recommendation to use a specific money management plan. Once a plan is chosen, all money is invested according to plan unless something changes. No more decisions to made, buying, selling, what to invest in, when to invest, all of that is already decided. The Advisor makes changes as needed. No more commissions so changes can be made without hesitation. Often, the money is managed by a team of professional money managers. Their only job is to make investments perform like they are instructed to. For example, your broker or advisor goes to lunch, has four appointments for the day, takes a two week vacation, or takes the afternoon off to play golf. With the Investment Advisor, your money is still being closely monitored and changes made as needed. With your broker, well, good luck!
In my opinion, most of the fee based arrangement or managed money idea is better. It takes away the conflict of interest of commissions. It creates a win-win atmosphere where your Advisor makes more money only when you make more money. It also creates a fiduciary arrangement where the investor has a layer of protection against financial professionals that either don't know what they are doing or let their own pocket books get in the way of the client's best interest. Managed Advisory accounts also add a couple of layers of protection and professionals that only manage money. They also keep your investments actively monitored and managed in case your Advisor or Broker takes a day off or is busy doing other things. My opinion is no secret, I believe wholeheartedly in the Investment Advisor over the commission arrangement in most cases.
As always, be sure to contact your Investment Advisor before making any changes to your investments. Seek out quality advice for quality results.
Thanks for reading! If you have investments that are down right now, please give me a call or contact me through my website. I can show you a way to recover a large chunk of your losses instantly and never have your investments go down again.
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