Firm Structures
Let me tell you a quick story about you (yea, you)…
You work for a few decades, you save a bunch of money, you make some good investments and some bad ones, you get lucky and unlucky at times, and you end up with some wealth.
With that wealth comes complexity.
Your needs and wants evolve. Financial markets move at a greater and greater speed. The tax code adds maddening new layers of complexity. The list goes on.
You think it may be time for some help from an advisor, so you start looking.
But where do you start?
Should you attend that free steak dinner and seminar you were invited to (likely via mail)?
Your bank has a wealth management division, perhaps you should contact them?
Your family member has “a guy" or “a gal” who they work with. Maybe they could give you a referral.
There’s an Edward Jones branch location next to your local grocery store, that sure would be convenient.
…But, just as we mentioned above, this is your life’s work and each of us has a single, once in a lifetime shot at building and preserving wealth to support how we want our lives to look. That’s a lot of pressure to put on a hiring decision.
The rest of this blog helps unpack some of your choices, specifically the structures of firms and how they can impact the kinds of advice you might receive.
(If you’re a client of ours reading this, clearly you’ve already hired someone and I deeply appreciate the trust and support… it’s never a bad time to refresh ourselves on the investment firm landscape and how Harding Wealth fits in.)
First off, let me state the obvious:
Financial advisors don’t always have the best reputation (understandably so).
…and that reputation is earned. Guys like Bernie Madoff make headlines for the criminally-bad things they’ve done with client assets, but much more often the offense isn’t criminal in nature, it’s simply a misdiagnosis on the part of the advisor — and misdiagnosis of strategy is more likely to happen when an advisor has financial incentives to recommend one thing over another.
I’ve seen the variance between good and bad professionals in our industry first-hand. Unfortunately, it can be hard to identify the good from the bad in advance, but you also don’t want to spend a decade finding out that someone is bad in retrospect (some life insurance and annuity investment strategies often take many years before it’s obvious how bad they are… We should try to avoid that.).
While there is no one certain way to avoid a bad advisor, there are two things I think help tilt the odds in your favor of finding someone who will provide good advice:
1) Understand their firm structure, and
2) Understand their designations.
In this post I’m going to run through the kinds of firms advisors work within. In a few days I’m going to outline some advisor designations (like the CFP designation I have).
Okay, let’s get into it.
Types of Firms
When working with an advisor, the quality of the person matters, but they are also beholden to firm they work in.
For example, Gordon Ramsey is one of the most famous chefs in the world, but if he works in the back of the house at Applebees then he’s forced to only cook the recipes which have been approved by the Applebee’s Bigwigs behind the scenes at the restaurant giant. In this case, Ramsey’s technical skill as a chef is outweighed by the motives of the company he works for… After all, if Applebee’s is making more than $4B a year then they don’t exactly care for chef-inspired customization of your meal. Their goal is the mass production of a product with high profit margins.
Here are the kinds of financial firms your chef/advisor may work in.
Independent Registered Investment Advisor
This is how my firm, Harding Wealth Inc., is structured.
First and foremost, we must be a fiduciary (i.e. put the client’s best interest before our own). This is important.
Independent RIAs choose a custodial partner, Altruist in my case, where client portfolios are held and managed. Platforms like Altruist, Schwab, ETrade, or Fidelity are very good at keeping costs low and services high for their account holders. Further, they can hold a very wide range of investments which gives independent advisors a lot of flexibility to pick what they believe is best for clients and their objectives.
I am able to pick and choose which firm functions to operate in-house and which to outsource. As an example, rather than employ a team of internal analysts to invent a proprietary strategy, I instead lean heavily on the research capacity of financial behemoths like Vanguard and Dimensional Fund Advisors (and others), to dissect and evaluate markets and to provide research to help form recommendations. It doesn’t make any sense for me to try and develop an in-house mutual fund when outside institutions have the expertise and capacity to do better than I ever could.
On the other hand, before starting Harding Wealth I had previously been the head of trading at a firm with more than $700m in client assets — so I’m comfortable handling the trading (like buying and selling of mutual funds) for our firm in-house where we manage just shy of $100m in client assets.
Being independent means the advisor and client can both agree on a fee arrangement that works for each party and move forward confidently. These fees may be a % of the portfolio, a fixed monthly fee, or even a one-time financial planning fee.
Notably, Independent Registered Investment Advisors do not collect commissions from selling products. In my experience, the more revenue sources a firm has, the more likely there is to be conflicting interests.
Independent firms like ours only have one revenue source: our clients.
When I built this firm from scratch in 2016, I picked this method of compensation because it works well with the kinds of advice I want to give and the kinds of clients I like to work with. When you don’t sell “a thing” it enables you, as the advisor, to make the client and their goals the “hero of the story” — When you sell a product, the advisor has to convince the client that the product is the hero.
I made this sketch a while back on this subject…(more on Superman at the bottom of this post).
Okay, on to the next one.
Broker Dealer
There are thousands of broker-dealers which break down essentially to two broad categories:
a wirehouse, which sells its own products, or
an independent broker-dealer, which sells products from outside sources.
First let’s discuss Wirehouses.
Most modern wirehouses provide a comprehensive range of services, such as investment banking, research, trading, and wealth management. They do a lot of things, which means they make money in a lot of ways that can be complicated to track as a client — and how advisors are compensated is important in helping understand their motivations and how you fit into things.
They often have proprietary strategies and can be motivated to sell them to their clients (perhaps no proprietary strategy has drawn more attention than selling mortgage backed securities prior to the collapse in 2007-2008).
Is the advice given by wirehouse advisors always bad? Definitely not. After all, there is the potential for them to use their size and connectedness to offer investors special opportunities like lower mortgage interest rates for wealth management clients or access to IPOs, etc..
Are there conflicting interests? Almost always.
Examples of notable wirehouses include Bank of America Merrill Lynch, Wells Fargo, and Morgan Stanley.
Independent broker-dealers are very similar to wirehouses only they don’t traditionally offer their own strategies to sell to clients. They do, however, often maintain their own accounts full of securities (stocks, bonds, mutual funds, ETFs, etc.) which they buy and sell at the same time they’re recommending a client buy and sell certain investments. This carries the appearance that they may be, in effect, encouraging a client to buy an investment they would want to personally sell or vice versa. As long as the advisor can defend that the recommendation as “suitable” there is no problem with the firm making a transaction that has the potential to benefit the financial firm more than the client.
Because the firm can earn commissions from recommending one thing over another, a broker dealer is not a fiduciary. However, I personally know some great advisors who operate within an independent broker dealer. Being a fiduciary is not a guarantee of giving good advice.
Some of the largest and most well-known firms include LPL Financial, Raymond James, Royal Alliance, Commonwealth, Cambridge, and Securian Financial. Additionally, some firms are effectively a hybrid between wirehouses and independent broker dealers, such as Ameriprise, Lincoln, AXA, Northwestern Mutual and Waddell & Reed.
Hybrid Registered Investment Advisor
Here’s where things get a little interesting.
Advisors can join or establish their own Registered Investment Advisor firm (like Harding Wealth) if they only want to work with clients in a fiduciary capacity, provide full-service wealth management, and generate revenues through a fee-based relationship without earning a commission for selling a certain thing.
Like us, the RIA will have custodial partners (like Charles Schwab, Altruist, Fidelity, etc.) in which the advisor can access accounts, strategies, and investment platforms to offer clients.
However, in a Hybrid RIA, the advisor may still have clients that pay commissions. A hybrid RIA is simply an RIA with both a custodial and a broker/dealer partner to conduct fee-based and commissionable business respectively. The advisor can, in effect, put on their “Fiduciary Hat” and sell their services to clients as an RIA, or they can take that hat off and sell commissioned products over on the broker/dealer side of the business.
Tip: If you want a fiduciary advisor, it’s important to ask “Are you always a fiduciary?” and ask for a written response.
Although I don’t personally offer this model (specifically to avoid the conflicts of interest that come with selling commissioned investment products) this model is not always a “bad thing.” Here’s an example to highlight this:
Let’s say someone needs ongoing advice about the various things that come up in their financial lives: education planning for children, investing for retirement, social security strategies, real estate transactions, etc. but they don’t currently have a big investment portfolio to manage.
Assume they currently have $10k to invest. A firm like mine would earn $100/yr, which is not enough revenue to profitably serve that client. Profit isn’t everything, but having the time to work with your clients is. For $100/yr I wouldn’t be able to have the time to give people the attention they need and deserve, especially after considering my overhead expenses.
However, a Hybrid Advisor could decide to sell this person a product with a commission attached and make, let’s say, $500 on the $10k investment. The economics of this arrangement work out a little better for the advisor and the investor may still end up getting some of the financial advice they seek.
(Although it is worth noting the “disappearing act” advisors may engage in after they receive an up-front commission payment for their advice.)
I know a lot of really great advisors with this business model. It’s not for me, but it’s not terrible either.
Insurance advisor
Insurance advisors are trained and licensed to give advice about and sell insurance. That’s it.
Some specialize in certain products, such as property or life insurance. Others sell a range of insurance products. Some insurance advisors may also be registered to sell investments (like annuities).
They’re usually paid by the companies whose products they sell and they make money every time they sell a policy. If you decide to buy, the cost is built into your insurance payments. My email address is on a bunch of distribution lists for insurance brokerages and, unfortunately, the headlines of many of their emails are centered on how much I, as the agent, would make if I recommended a certain thing to my clients. Not good.
For many people, insurance is an important part of a well-rounded financial plan. However, it can be hard to get objective advice from someone who is only compensated by you buying the thing they sell. If you need insurance I think it’s best to get a diagnosis of that need from someone without conflicting interests (that person is me for our clients).
Up until this year, I had an active insurance license. I may reinstate it in the future, but only if a specific kind of client need arises for term life insurance (like a buy-sell agreement for a business, for example). Until then, I help clients determine insurance needs and then outsource the work to an insurance advisor. I know many who are good.
Conclusion
There is no guarantee that your experience will be a certain way in any of these firm structures. If you want to work with someone, the only thing you can do is try to find a situation where you know and understand their motivations and are comfortable that your interests are being looked after.
That’s all for this week. Until next time.
Onward,
Adam Harding CFP
PS… Sticking with the Superman theme from the drawing above, I thought I’d share this picture of my kid enjoying the mountains in Idaho last week in his Superman pajamas.
Never underestimate the return on investment of some fresh air and quality time with the family.
