When you start thinking about hiring a financial advisor, there are an overwhelming number of questions to ask.
Most people assume all financial advisors are created equal, but the reality is that they fall into two main categories: Registered Investment Advisors (RIA) and Broker-Dealers.
Knowing that, the next question should be (but usually isn’t): what’s the difference and what’s the better option for me?
These two types of firms differ substantially in roles, regulatory frameworks, fee structures, and fiduciary responsibilities.
When a prospective client has an existing relationship with an advisor, it’s natural for them to ask if their advisor is doing a good job, or if they have the right type of advisor to begin with. To answer this question, the firm-level is where I start.
What is a Registered Investment Advisor?
First, let’s talk about what a Registered Investment Advisor (RIA) is. As the name implies, an RIA provides personalized investment advice, asset management, and financial planning services.
Most RIAs offer some level of comprehensive financial advice tailored to the individual needs of their clients, particularly if they carry Certified Financial Planner designations.
Beyond investment management, RIAs often provide financial services for other client needs like estate planning, retirement planning, tax planning, and more.
How are Registered Investment Advisor Firms Regulated?
RIAs are regulated by the Securities and Exchange Commission (SEC) if they manage assets over $100 million, or by state regulators if they manage less. They also must register under the Investment Advisers Act of 1940, an act put in place after the depression to make sure the public had ways to better trust the investment and financial advice they received.
Because of this oversight, RIAs are legally obligated to act in the best interests of their clients at all times according to their fiduciary standard (more on that below). This includes providing full disclosure of any potential conflicts of interest.
Some RIAs, including Plancorp, have gone a step further in their fiduciary commitment by registering with the Certified Centre for Fiduciary Excellence (CEFEX).
CEFEX firms must uphold fiduciary practices that exceed the letter of the law and agree to annual audits to confirm their approach. These audits are more rigorous—and more frequent—than the SEC’s approach to checking up on fiduciary commitments, and Plancorp is proud to be among the first firms to receive this certification as well as pass certification every year since, for a total of 15 years certified in our fiduciary standards.
Compensation Structure of RIA Services
I also get asked “how do you get paid?” a lot as a financial advisor. The nice thing is, the answer is easy: RIAs are independent of any investment product, they are only selling their advice, which gives them the ability to remain genuinely impartial.
You can juxtapose this to common services like fund managers, insurance or annuity providers, etc. who may offer you some services for “free” while making commission on the products they sell or move your assets into.
RIAs are independent because they are paid solely by their clients for their impartial advice, not referral fees or kickbacks. You may hear this referred to as ‘fee-only advisory services.’
Because RIAs are paid only by their clients, they’re able to be agnostic and objective in performing their fiduciary duty to clients. As fiduciaries, the only compensation they receive is the fee charged to clients.
Standards of Care at Registered Investment Advisor Firms
Expanding on the themes above, because of their independent nature, it is a RIA’s job to choose the best portfolio of investments for their client—NOT the portfolio that maximizes commissions. This means the recommendations that RIAs make will be in their client’s best interest and support the overall financial goals of the client rather than the firm itself.
Clients who partner with RIAs like Plancorp are generally advised to choose the lowest cost investments in any given space of the market (matching your asset allocation strategy) with returns comparable to their benchmarks.
RIAs can also recommend CPAs and attorneys for complementary services and work alongside them, and are often able to save clients expensive hours of those experts’ time.
What is a Broker-Dealer?
Usually when I describe an RIA, I hear people say “oh that’s what my money person does” but they may be shocked to learn that they are actually working with what is known as a broker-dealer, not an RIA.
A Broker-Dealer primarily facilitates the buying and selling of securities on behalf of clients. Over time to stay competitive with RIA services, they have started to offer supplemental financial planning services through something known as dual registration, but for the most part they act as brokers (agents for clients) or dealers (trading for their own accounts).
How are Broker-Dealers Regulated?
Broker-Dealers are regulated by the Financial Industry Regulatory Authority (FINRA) and the SEC. They must adhere to rules under the Securities Exchange Act of 1934 and other relevant regulations.
Often, the firm where your 401(k) is held is a broker-dealer. You likely receive calls from them from time to time, especially if you are doing a great job saving into your plan.
Compensation Structure of Broker-Dealer Services
While on the service, it may seem like broker-dealers are very similar to RIA’s, how they get paid is where things really start to diverge. Broker-Dealers often earn commissions on the trades they execute and on the sale of financial products such as mutual funds, annuities, and insurance, which can sometimes lead to potential conflicts of interest.
They may tell you these investment recommendations are free to you as a 401(k) participant—but remember, if there are no ‘costs’ to you for a product you use, you are no longer the customer—you are the product.
Standards of Care at Broker-Dealer Firms
Broker-Dealers are subject only to a suitability standard, which requires them to recommend products that are suitable for clients based on their needs and circumstances, but not necessarily the best possible option. Generally, this is enforced as them being held to recommend investment products that don’t actively harm a client, as opposed to what their best fit is.
Pressure testing this idea in action, it means they are free (and candidly, incentivized) to recommend investment strategies that result in their firm or them as the advisor being paid a higher fee or commission.
Let’s put this in terms you likely hear a lot while you’re evaluating finding financial advice. A broker-dealer may tell you that they are acting as a fiduciary. For your retirement accounts which are governed by the Department of Labor, this is required—however, broker-dealers are not held to a fiduciary standard for all activities, and may still be applying a suitability standard in your non-retirement accounts because they are dually-registered, meaning you must personally trust that they won’t make recommendations that enhance their bottom line, because there are no legal guarantees of that.
Broker-Dealer vs. RIA: Which is Better for Me?
So which type of firm is best for your financial situation? As with so many things, it depends, but this one is pretty straightforward in my mind.
It's not fool-proof, but a simple measure is your net worth and accumulation of investable assets. Most RIA firms have a minimum annual fee based on assets under management (AUM), which makes this level of service less cost effective at lower levels of accumulated assets.
If you’re building your 401(k) with your employer and maybe starting taxable savings or a Roth IRA you might be fine without either relationship if you’re willing to do a little extra digging to save on the costs of fees.
If you need basic investment advice and prefer to focus on other things, a broker-dealer relationship may work well for you while you’re getting settled.
The trap I see a lot of people fall into is missing when they've outgrown basic advice. Once savings outside of your 401(k) are tipping into six figures, I believe it's time to at least meet with an RIA to understand what that comprehensive and cohesive level of financial planning could do for you.
If you already have a relationship with a broker-dealer it can be even harder to make the leap, but the best advice I've heard is to understand that the skills and advice that got you where you're at today likely isn't what will get you to your future goals. In more specific terms, the advisor who specializes in helping you establish savings plans likely isn't as well-versed in lifetime tax strategies, estate planning, and generational wealth transfer.
If you are looking to switch, here is a great article to guide you on the transition.
Even if it’s not yet the time to start working with a financial advisor, it’s important to get a gut check on your financial picture, establish a relationship with an advisor, and continue moving in the right direction of building your savings.
Our 2-minute financial analysis is a great place to start and will provide you personalized recommendations and resources curated to your financial goals.
