Selecting someone who is being paid to provide you with investment advice is a crucial decision. You want to make sure that the adviser you select is working in your best interests and that your retirement savings are protected.
While there are rules to the use of the terms "Fiduciary", or "Financial Advisor", they're often ignored. At Gulf Coast Financial Advisors we respect these terms, and our business is set up so that if you, the client, do better, we do better. Here's how that works.
We'll start with a brief history lesson: What is the difference between a Broker and an Advisor?
A Financial Advisor is a professional hired to pick stocks, bonds, mutual funds, exchange traded funds (ETFs), real estate investment trusts (REITs) and other investments for clients. As Advisors, we are required to act as a fiduciaries, which means we're legally obliged to act in our clients' best interests. A significant part of this structure is how are are paid, and by whom. For our Investment Management and Qualified Retirement Plans clients, we typically charge a percentage "AUM" fee, which stands for Assets Under Management. AUM fees are intended to align the interests of the advisor with the client - the client does better, the advisor does better; consequently, client makes less, advisor makes less. For our Financial Planning clients, we offer a flat fee, hourly rate, or subscription fee; these fees are sometimes waived based on the amount of assets managed for the client. All our fees are paid directly by the client.
By contrast, the word "Broker" is short for stockbroker—someone working for an investment firm whose job it is to persuade a client to buy or sell stocks, bonds, mutual funds, ETFs and other financial products. Brokers are salespeople and paid a commission per transaction, therefore, if there is no transaction, there is no pay. Ever had someone in the financial services industry call you with a hot stock or investment fund tip? That is a broker. Brokers are not fiduciaries, and operate under a different standard of care called “suitability.” Suitability means that a recommended investment only has to be suitable, or appropriate, for a client's situation, but does not have to chin the higher bar of operating only in the best interests of the client. Brokers are compensated by the companies that they represent; not by the client.
What role does Securities Licensing play in providing fiduciary services?
What can make it difficult to distinguish between the different types of advisors is all of the terms we operate under: financial advisor, financial services representative, financial planner, wealth manager, investment management, etc, etc. Add in the all of the "C" (CFA, CFP, et. al.) designations and it can get quite confusing. When it comes to a public facing, retail financial advisor, one way to cut through the clutter is to look at licensing. Often, how an advisor is securities licensed will dictate the solutions they present. Here are the security licenses you are most likely to encounter as a retail individual investor:
- Series 6: Investment Company & Variable Contracts Exam. This allows the advisor to sell mutual funds and variable insurance products, such as variable annuities and variable life insurance. You will often see this licensing with "registered reps" affiliated with large mutual life insurance companies.
- Series 7: General Securities Representative Exam. This is the classic definition of a stockbroker. Seen the movie Wall Street? Those were Series 7 licensed brokers selling stocks to prospects via cold calling. Remember - only Bud Fox was doing anything illegal, the rest of the brokers were only guilty of being pushy (and obnoxious). You will often see this licensing with someone affiliated with a "broker/dealer" or a brokerage / wirehouse firm.
- Series 65/66: Uniform Registered Investment Advisor Law Exam (66 combines 63 & 65). This allows the advisor to charge a fee directly to the client for advice, i.e., AUM fee, planning fee, hourly rate, etc. This is the classic definition of an "Investment Adviser Representative", or IAR. The important detail to note here is that advisors with only their Series 65 license can not accept a commission for the sale of an investment product, such as a sales load on a Class A mutual fund.
Take note: a "dually registered" advisor has both Series 7 and 65/66 licenses, which means they have both an affiliation with a broker/dealer and a RIA (sometimes called a "hybrid" arrangement) and can receive both sales commissions and client paid fees.
Here's the point: A fee-only and fee-based advisor will not have access to commissionable securities and variable insurance products in their investment choices. The only way they get compensated for investment work is directly by the client, typically in the form of AUM fees, planning fees or hourly rates. The goal of this structure is to remove any financial incentives for the advisor to pick one investment over another because the investments do NOT pay the advisor - the client does - meaning that in theory a major conflict of interest is removed from the advisor / client equation. Contrast this with a broker that receives a commission from the company who's security they just sold - not from the client - and that different companies sometimes offer different levels of commissions to brokers, even on similar investment products, and I believe you start to see where the conflicts of interest come in to play...and why it's almost impossible for a broker to claim they operate solely in a client's best interests.
Gulf Coast Financial Advisors only utilize our Series 65 licenses and do not place any business with any broker-dealer, which means we receive no commissions for the recommendation or sale of any security. This doesn't mean we're perfect advisors (or human beings), it just means that when it comes to our commission free investment advisory accounts, a major roadblock to operating in our client's best interests simply doesn't exist in our practice.
Does this mean that we have eliminated all conflicts of interests?
For our advisors that also have their life insurance licenses, the answer is no, there are times when the only viable risk management tool available is a fixed insurance product with a commission. Wait - what? As we detailed above, we are only able to receive fees from our investment management, financial planning and qualified retirement plan accounts, clearing the road of the most significant conflict of interest - commissionable securities and variable insurance products. But if you plan on working with us, you should know that some of our advisors have extensive experience in fixed insurance, particularly in life insurance, disability income insurance and long term care insurance.
These advisors use insurance products in 3 key areas of our practice: when assembling a comprehensive financial plan that has self-completing features; when offering long term disability income insurance to professionals, such as business owners, physicians, dentists and highly compensated employees (HCE); and when executing sophisticated executive / business owner level planning, such as key-person coverage or funding a buy-sell agreement. Our stance is that we cannot operate in your best interests if we don't have adequate downside protection for the unforeseen tragedies in life, such as premature death or disability.
While the insurance industry may some day find a way to provide a comprehensive level fee incentive versus the current commission model, the reality is that right now the only way to get the most robust, competitive and reliable insurance coverage for our clients is through the industry standard of paid commissions.
While fiduciary is an important term, there are also two other terms you need to understand: Discretion and Custody.
When it comes to YOUR money, often YOUR life savings, the bottom line is TRUST. Do you trust the advisor tasked with accomplishing your financial goals? Is how the advisor profits from the relationship transparent and easy to understand? And is the advisor set up in a manner that gives you the best chance of success?
Case in point: we've all seen the "American Greed" television series. Often that show is about a crook that takes investors' money and uses it for their own personal gain. All too often, it is someone in the financial services industry doing the theft. It's important to note this because while the term "Fiduciary" gobbles up a lot of the attention with investment advice, it is not the only term an investor should consider when placing their money. If the term fiduciary is important to you - and it should be - this example may shock you: for most of his career, Bernie Madoff was a broker, but from 2006 to 2008 he registered as an investment advisor with a supposed fiduciary responsibility. Wait - how could someone be a fiduciary yet still rob people? Because being a fiduciary is not the entire story. A lot of it comes down to who holds your money (custody), and who has decision making authority over it (discretion).
First, a financial advisor has discretion over your investments if they decide which securities to purchase and sell or they decide which investment advisors to retain on your behalf. This is typically the arrangement when you hire a financial advisor - you are bringing their expertise to the table to make investment choices for you. In fact, be wary if an advisor is asking you to make most major investment choices, it's a sign that they are operating as a broker and not an advisor.
In financial services, a custodian is a company that has physical possession of your financial assets. It's often a brokerage, commercial bank, or other type of institution that holds your money and investments for convenience and security. You've heard of a lot of these companies even if you didn't realize they offered custodian services: Schwab, TD Ameritrade (now owned by Schwab), Fidelity, Pershing, etc. For our individual investment clients, Gulf Coast Financial Advisors uses Schwab, which is one of the largest qualified custodians in the world, holding hundreds of billions in assets for clients and advisors’ clients. And - you'll see why this is so important below - Schwab provides you with a separate, independent statement of all balances and securities transactions.
So, as a fiduciary for part of his scheme, how did Madoff steal billions from his clients? Because he had both discretion (typically not a problem) AND custody (yikes). Because there was no separate accounting of the investments, Madoff was able to generate his own fake statements and create false returns. This is why it is so important to understand where your money is being held. A strong, well known custodian doesn't mean that there won't ever be any issues. Its just means that your money is held by a reputable, well established publicly traded company with account statements that offer a factual accounting of your investments.
Lastly, let's touch on disclosures.
One last piece of the trust pie is a Financial Advisor's disclosure. These are reports in which an advisor publicly releases details about their educational and business background, services they offer, and their record of conduct. You can find some of this information in financial advisor disclosure documents such as Form ADV, a registration document submitted to the SEC and state securities authorities.
A financial advisor disclosure can also refer more specifically to any past regulatory, criminal or disciplinary actions on a firm or advisor’s record. Disclosures can range in severity and include issues like customer complaints, arbitration and civil proceedings, sanctions and terminations. The goal of making this information publicly available is to level the playing field for all advisors (Source: SmartAsset).
Just as with fiduciary, custody or discretion, disclosures are not the total story of whether you should trust a financial advisor or not. But they are an important piece of the puzzle. By way of example, you can download GCFA's founder Josh Null's Form ADV Part 2B by clicking HERE, and you can find his SEC Investment Adviser Public Disclosure by clicking HERE. Again, the fact that Josh doesn't have an disciplinary infractions or negative disclosures doesn't mean he's an infallible financial advisor. Just as it doesn't mean that someone that has a few dings on their report is a bad actor. It's just one more piece of the overall puzzle to help you make your decision.
Where can I learn more?
The Department of Labor has a handy guide for investors - click the title to download: A Fiduciary Guide for Individual Consumers: How to Tell Whether Your Adviser is Working in Your Best Interest. Or just Google "Questions to ask a financial advisor" and you will have several great lists to reference. Ask us anything - we're happy to answer any of these questions for you. The client / advisor relationship is an important one that needs to work from both sides, so it's best to get the uncomfortable questions out of the way early.
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