How To Select A Financial Advisor: The Least You Should Know (Part 6 In eBook Series)

How To Select A Financial Advisor: The Least You Should Know (Part 6 In eBook Series)
Chapter 4:
The Type of Account You Maintain Matters

The type of investment account that you maintain will determine the extent to which you receive the protections offered by the fiduciary standard. Your account type also can affect the investment recommendations that you receive. Will your portfolio be comprised of cost-effective, tax-efficient investment vehicles? Or will it include financial products characterized by high annual expenses, surrender charges and unnecessary tax liability? Over time, these factors can make a huge difference in your account balance.

There are two basic account types: the Brokerage Account and the Advisory Account. What is the difference? Brokerage accounts must only meet the suitability standard, but advisory accounts must meet the fiduciary standard. To repeat from the previous chapter, the suitability standard provides far less protection for investors than does the fiduciary standard.
If you have a brokerage account, your financial advisor is typically compensated by commissions. Sometimes, these commissions are clearly identified, and sometimes they are not. Any advice you receive in your brokerage account is considered to be “incidental to the sale of securities.” In other words, your financial advisor is legally considered to only be conducting a transaction at your request, rather than giving you investment advice. This regulatory loophole leaves the advisor’s primary allegiance to his employer—not to his client. The brokerage firm has no fiduciary legal obligation to act in your best interests.

With an advisory account, the investor gets much greater transparency. The financial advisor and his firm have a fiduciary legal obligation to you. Typically, you will be charged an advisory fee each quarter (usually based on a percentage of the assets that the advisor is managing for you).

The Investment Advisers Act of 1940 requires that, for advisory accounts, your financial advisor must:
1.Always act in your best interests and in good faith.
2.Fully disclose any conflicts of interest.
3.Fully disclose any compensation from third-parties.

The key questions are: do you wish to receive financial recommendations from a financial advisor and firm that have no fiduciary obligation, and whose recommendations may be influenced by commissions? Or would you rather pay an advisory fee for ongoing financial advice from a person and firm legally obligated to always act in your best interests?

If you chose the latter, you need to open an advisory account. That is where your protection will be greater, and where your advisor is legally obligated to provide you with better disclosure about the costs of the investments you are selecting.

If you want a relationship based upon the disclosures and fiduciary duty of an advisory account, you have two choices. First, if you have a brokerage account, your account can be switched to an advisory account. This might make sense if you like your broker and feel that he understands your needs. The broker would need a Series 65 or Series 66 securities license so he can operate as an investment advisor and fiduciary. Otherwise, you will still be compensating your broker through commissions. Commissions are acceptable if you do not require ongoing personalized investment advice. Just be sure that the commission is clearly identified. If you are purchasing financial products, such as mutual funds and annuities, request an itemized report identifying the investment’s annual operating expenses, as well as a comparison to a low-cost alternative, such as a Vanguard index fund or variable annuity. Be advised that this is an unusual request, but don’t be deterred. The differences will be quite eye-opening.

Your other alternative is to find another advisor and open an advisory account to utilize an advisor who works under the fiduciary standard. Fortunately, many of these advisors are available. In Chapter 21, I provide a list of questions from material developed by the National Association of Personal Financial Advisors (www.napfa.org) that will help you identify a fiduciary advisor.
Appendix A features an article from InvestmentNews—a cautionary tale for those who are not working with a fiduciary.

In the next chapter, I provide more detail about the three primary types of advisor business models, and identify which ones automatically operate under a strict fiduciary obligation to their clients.

“The big print giveth, and the small print taketh away.”
~Tom Alan Watts, American Singer, Songwriter, Musician

Have a question? Contact Ed Mahaffy.

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