Let’s Play A Game: Fiduciary or Salesman?

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If you walk into a candy store and ask the owner what you should get, you wouldn’t expect him to say eat an apple. We know he’s in the business of selling candy. Yet many people ask their brokers for financial advice and expect objective answers.

In recent years, the lines between investment advisors and salesmen have blurred, particularly the way they are marketed to consumers. Banks and brokerage firms increasingly represent themselves as financial advisors with your best interests at heart. It’s vital to understand the difference when working with either.

Only a registered investment advisor has a fiduciary duty to put your interests first. RIAs (registered investment advisors) have been licensed and approved by the SEC or a similar state agency to dole out investment advice. Implicit in their fiduciary responsibility is the duty of care (they will handle your assets as any rational person would), duty of loyalty (they will put your interest over their own), and duty of good faith (they won’t trick you). The standards for salesmen, if any, are less scrupulous.

If the salesman is a broker-dealer registered with the FINRA, they are bound by a suitability standard, which means they must sell you products that fit your needs. That does not, however, mean it has to be the best option available. You may think the difference is semantic. However, these standards matter because they determine how the advisor’s interests are aligned. A fiduciary is bound to serve their client, while a broker’s loyalties lie with his employer.

Imagine that you went to a dealership looking to buy a sports utility vehicle. Based on suitability standards, a broker would have to sell you an SUV. They could not push a truck that has been sitting on the lot for months that the dealer needs to sell. A fiduciary, however, might tell you there was a vehicle at another dealer down the street with more of the features you want, and at a lower price. Instead of cars, brokers are selling you investment products.

 You might wonder why financial advisors can be held to such different standards. In the eyes of the SEC, registered investment advisors are the ones you go to for financial advice. The primary role of broker-dealers is maintaining the liquidity of capital markets, by connecting buyers with investments.

While a fiduciary must place your interest above theirs, broker-dealers have no obligation to put their interests below yours. For example, by law, fiduciaries must attempt “best execution” when handling transactions for clients. Brokers, on the other hand, are only required to avoid excessive trading and other obviously detrimental activities.

Part of the problem is compensation structure. While an RIA may charge you a percentage of assets under management, or a set rate for their advice, brokers work on commission. This might be based on a percentage of assets they have invested for you, a fee paid by the client per transaction executed, or a seller commission from the financial institution. Brokers therefore have an incentive to push whatever products would result in a bigger kickback for them.

By law, an RIA is not allowed to push, or buy products on your behalf, simply because they would receive a higher commission than with a comparable product. The suitability standard only restricts brokers from selling you a different product entirely. They are not barred from recommending the choice that best benefits themselves. For example, they might push proprietary products that cost more than comparable options because it would result in a bigger commission for them.

It’s important to also look at your advisor’s employer. He or she could be working for an independent broker-dealer, or for a wiring house that are telling their salesmen what merchandise to promote. A salesman may also push investment options that benefit their personal portfolios. With a fiduciary, you can be fairly certain you are getting an unbiased recommendation. That’s because fiduciaries are required to disclose and eliminate any and all conflicts of interests.

There is a time and place for using a brokerage. Broker-dealers typically offer a wider range of investment options, including insurance. However, this is changing. RIAs are increasingly offering alternative investment products in order to compete.

Banks and financial advisors both have their place in your investment strategy. However, it’s vital to understand the differences and be aware of any areas where your advisor (fiduciary or not) may be biased.