Financial Advice & The Questions To Ask

16256029_sIn my private practice, I teach my clients the questions they need to be asking themselves so they can make the right decisions for their financial future. Today, I want to spend some time with you explaining a very hot topic—the differences between different kinds of investors.
In the world of investing, there are basically two kinds of investors, retail investors and institutional, or wholesale, investors. Retail investors, generally, are smaller, individual investors who invest in the markets for their own personal gain. Institutional investors, on the other hand, are exactly that, large institutions such as banks, insurance companies, pension funds, and charitable foundations.
Historically, there have been many differences between the two types of investors, including the size and pricing of the trades each makes and the level of investment advice available to each. And historically, the big guys received better selection and pricing in the world of finance. But now, it does not need to be that way.
Institutional investors typically place large trades in blocks of 10,000 shares or more, whereas retail investors place much smaller trades in either individual stocks, or shares of one of the most common instruments sold in the retail world, mutual funds. Mutual funds are designed to give the general public easy access to the financial markets. Nevertheless, distribution and marketing costs, combined with trading commissions (which are not always transparent), are built into these retail products, thereby making them costly to the individual investor and profitable for the brokerage house and the broker who is selling them.
You see, institutional investors, on the other hand, have access to lower pricing structures and different share classes because they are buying and selling such large quantities. Additionally, unlike the trading costs usually hidden inside many retail investment products such as mutual funds, the institutional investor receives full transparency on the costs associated with their strategy. Institutional investments are held within separate accounts that are supervised by third-party custodians, such as Fidelity Institutional Wealth Services, TD Ameritrade Institutional, Pershing Institutional, Wells Fargo Institutional and Trust Company of America Institutional. The securities are registered in the name of the institutional investor and traded on its behalf.
Most retail/individual investors access the markets through the retail brokerage system, either by going directly to the large brokerage houses, or to a broker affiliated with a brokerage house. Brokerage houses, for the most part, package goods and services that can be sold to the general public. A broker is a guy or gal selling that package of goods and services who introduces a willing buyer (you) to a willing seller. A broker’s primary job is to close the transaction between you, and the brokerage house. For their services, brokers are paid a commission, which is often based on both the amount of product that they sell and the kind of investment they are offering.
A frequent misconception is that a broker has a responsibility to offer investment advice that is in the best interest of his or her client. They do not; they are only required to offer advice and recommend products that are “suitable” to their client’s given situation.
Institutional investors, on the other hand, typically do not use retail brokers for investment guidance. Institutional investors will use third-party money managers that are registered investment advisor (RIAs). Registered investment advisors, generally, are held to a fiduciary standard, which means that the advisor must put the client’s best interests first. Other professions that are held to a fiduciary standard include certified public accountants, physicians, and lawyers. In addition to putting a client’s best interests first, a financial professional held to a fiduciary standard must act with prudence, cannot mislead, and must fully disclose and fairly manage the client’s assets in the client’s favor.
Historically, the third-party money managers that most institutional investors use were available only to those institutions or very high net worth individuals. But now, through advancements in technology, institutional money managers will work with individual investors through third-party RIAs and the investment advisor representatives (IARs) who are affiliated with such registered investment advisory firms. And get this, institutional advisors can sometimes help investments bypass the additional costs associated with retail brokerage houses and brokers. You basically avoid the extra costs associated with the retail distribution and marketing powerhouses.
Actually, in many cases, the same money managers found within the mutual funds sold on the brokerage and retail side can work with your advisor without the additional costs associated with the retail products and funds.
But please be aware of those “advisors” who are both brokers and registered investment advisors and/or investment advisor representatives. When an individual is licensed as both, they are only held to the higher fiduciary standard if their investment advice is incidental to their business as a broker.
Hmm. Seriously? Incidental?
Okay, let me introduce Laura Shin from Forbes and author of the book “The Millennial Game Plan: Career And Money Secrets For Today’s World” into our discussion. Ms. Shin has coined these folks “Hybrid Advisors.” In essence, Hybrids can operate as fiduciaries some of the time and as brokers some of the time. And there’s no mandatory disclosure explaining a Hybrid’s role and potential conflicts, so it’s up to the investor, that’s you, to ask the advisor the right questions.
So, my friends, take some advice from Ms. Shin and Forbes. The first step is to check the SEC’s investment advisor database (tinyurl.com/cwr7juf). There you will find if your advisor is an RIA, IAR, or dually licensed as a broker. If he or she is dually licensed, then you really need to ask how he or she is paid. You should ask if he or she is paid commissions on the financial products suggested. You must ask how you will know when the advisor is working as a fiduciary for you rather than as a broker. Also, is it 100 percent of the time? Lastly, understand the differences between a “fee-only” advisor and someone who is “fee-based.” As Ms. Shin explains, if someone is “fee-only” that usually means he or she will act as a fiduciary 100 percent of the time; he or she will always give you advice that is in your best interest.
Folks, it is tricky out there. Make sure you ask the right questions so you can make sound financial decisions.
Be vigilant and stay alert, because you deserve more.