YOUR INVESTMENT COACH

The Difference Between a Stockbroker and a Registered Investment Adviser

When I ask potential clients where they get their investment advice, the most frequent response I get is “I deal with a stockbroker”. Most also say they have never heard of a registered investment adviser, and have no idea what the difference is between the two. If you fit into this category, please continue reading.

A fiduciary is someone who manages money for the benefit of another (beneficiary). A fiduciary is bound by law to place the interest of its beneficiary first – even ahead of his own interest. You would think that anyone offering investment advice to clients is a fiduciary. If you think that, you would be wrong.

Stockbrokers are not fiduciaries. Also known as registered representatives, account executives, financial consultants, wealth managers, or brokers, they are first and foremost, sales agents. Stockbrokers have an employment contract with their brokerage firm that requires them to produce revenue from the commissions generated when they buy or sell a security product. The only ‘fiduciary’ duty the stockbroker has is to make money for his/her company (and himself).

All stockbrokers must be registered with the Financial Industry Regulatory Authority (FINRA) in order to buy or sell securities. Many brokers provide advice and guidance on the specific investments that they recommend in their transaction-based client relationship. When doing so, they are governed by FINRA/NASD Rule 2310, commonly known as the ‘suitability rule’. It provides in part (a) that, “In recommending to a customer the purchase, sale, or exchange of any security, a member shall have reasonable grounds for believing the recommendations are suitable for such customer …”.  This ‘suitability’ standard does not require him to place the interest of his customer ahead of his own. He needs to provide only ‘suitable’ advice to his customer – even if the stockbroker knows that the advice is not the best advice.

A registered investment adviser renders investment advice to his clients on a fee basis, usually as an annual percentage of the account value, or as an hourly consulting fee. He gets no commissions or fees, and his incentive is to make the client’s account grow in value, as his success depends on the client’s success.

Contrary to the stockbroker, a registered investment adviser is a fiduciary. Governed by the Investment Advisers Act of 1940, he is held to the ‘trust’ standard – the highest known in law – that requires him to place the interests of the client above his own. He must fulfill the critical fiduciary duties of trust and confidence, and, by law, the registered investment adviser must provide the ‘best advice’ to his client.

For example, let's say that a large-cap growth fund is determined to be what you should have in your portfolio. There are about 1,650 to choose from. The stockbroker (who is employed by ABC brokerage house) could recommend the ABC Large Cap Growth fund, which has average ratings and a 5.75% load (sales fee), as a ‘suitable’ investment. Right off the bat, only $9,425 (of your $10,000 investment) is working for you, and you can expect only average performance on the lesser amount invested.

The registered investment adviser would research the 1,650 funds and recommend the ‘best’ large-cap growth fund he could find. His choice for you would be the fund with superior overall ratings based on performance, how it compares to other funds within its large-cap growth category, the quality and volatility of the holdings, the risk-to-reward ratios, the fund manager’s tenure, the load/fee structure, expenses, and other factors. It would most likely be a 'no-load' fund, so all $10,000 would be working for you and you could expect better than average performance with the least acceptable risk.