The word independent can be described as autonomous, unbound by another entities force, direction or will, or perhaps and most importantly freedom. But in the context of your financial advisory relationship independence means much, much more. To understand just why the independent financial advisor model is so vital to your long term financial success, you must understand the difference in advisory models from the ground level up.
According to a survey by Cerulli Associates, an industry polling and research firm, the channels of financial services models can be broken down into roughly six major categories:
National Full Service Brokerage – These are firms such as Merrill Lynch, Smith Barney, Morgan Stanley and Goldman Sachs. A financial advisor at one of these firms works for their employer directly, but can provide financial advisor services and sell you insurance and investment products (maximizing profits and enriching company value). There are approximately 70,000 “financial advisors” at national full service brokerage firms.
Regional Full Service Brokerage – These are smaller geographically specific brokerage firms such as Robert W. Baird, Edward Jones, and AG Edwards. Regional brokerage firms are nearly identical to their national counterparts in business model, however they’re smaller in size and typically geographically anchored to service a smaller segment of investors. There are approximately 15,000 “financial advisors” at these smaller regional full service brokerage firms.
Independent Broker-Dealers – These are firms such as LPL Financial (Linsco Private Ledger), Associated Securities Corp., Ameriprise and ING. A broker-dealer acts as either a sales organization selling consumers investment and/or insurance products OR as a buyer of securities. Some broker-dealers act in both capacities. There are approximately 100,000 “financial advisors” at independent broker-dealers.
Bank Brokerages – These are banking institutions who also offer financial advisor and investment management services to their banking customers. Banks such as Wells Fargo, Bank of America and Citigroup offer these services and employ roughly 15,000 “financial advisors”.
Insurance Broker-Dealers – Firms such as New York Life, ING, AXA Advisors, Equitable, and Transamerica are involved in the exchange of insurance contracts and services from company to consumer. There are roughly 35,000 “financial advisors” in such firms.
Registered Investment Advisor Firms – There are roughly 25,000 Registered Investment Advisor Firms. A Registered Investment Advisor (RIA) is a firm registered directly with the Securities and Exchange Commission (SEC) or their state securities licensing division. My firm Red Rock Wealth Management is an SEC Registered Investment Advisor Firm. Nearly half of all Registered Investment Advisor firms are also working with or through a broker-dealer (at some level) however to facilitate investment and insurance transactions.
Removing the RIA’s with broker-dealer affiliations this means roughly 5% of “financial advisors” are solely in the Registered Investment Advisor model.
The words “financial advisors” are in quotations because these firms hold their employees out to the public in a financial advisor capacity, yet they may or may not be true financial advisors depending on their employment status. In fact, they may be nothing more than facilitators of brokerage transactions for insurance and investment products.
Why is this industry knowledge important to you and your financial future? Because there are varying levels of DEPENDENCE in the first five models for financial advisors. The pure Registered Investment Advisor model with no broker-dealer affiliation is the only completely INDEPENDENT model.
To be clear, many financial advisors at independent broker-dealers like LPL consider themselves independent, and provide financial services in that manner. However there are still issues of reliance on the company that pays their commission checks. Outside of the RIA model however, the independent broker-dealer is the closest thing to a purely independent financial advisor practice.
To fully grasp why the national and regional brokerage firms, the bank brokers, the insurance brokers, and the independent brokers are not independent, simply look at who writes their paycheck. Unless you’ve never been employed, you understand clearly that your paycheck is contingent upon fulfilling your duties to your employer as your employer describes said duties, period – end of story.
If your employer is “calling the shots”, to maintain employment and get your paycheck – you fall in line, you follow orders. You do so regardless of whether those shots the employer calls are in your clients best interests or not. To earn a living – you follow orders. This concept is clear and unwavering whether you’re flipping burgers for McDonald’s and must prepare food a certain way, or if your a Fortune 500 CEO and accountable to shareholders and a Board of Directors. If you work for someone else, you’re dependent on fulfilling their idea of what your job description is.
If your financial advisor is beholden to their employer (and 95% of financial advisors are) they’re dependent on that entity for income, benefits, and job security. If they’re dependent on their employer, they must fall in line and follow company orders.
But that’s not so bad is it? 95% of financial advisor representatives being dependent on the company they work for to earn a living? It is if the company they represent is in turn beholden to maximizing profits and increasing shareholder satisfaction. If the financial advice given to you is somehow influenced by corporate profits, how can you be certain it’s in your best interests?
There are several reasons an INDEPENDENT financial advisor will have the upper hand when it comes to providing unbiased financial advice and guidance, but to name a few:
No Proprietary Products – Each of the first five models may create, manage, and sell their own investment and insurance products, or in many cases they have “special arrangements” with other firms to promote and sell “preferred” investment and insurance products. By “special arrangement” I mean kickbacks, a commission, compensation, additional business benefit, etc. The fact is, whether the products are truly proprietary or a special arrangement is made, if the company receives a financial benefit to sell certain investment and insurance products it’s effect is proprietary in nature, as it clearly identifies a conflict of interest.
Highly Profitable Insurance and Investment Products – Perhaps the most common form of abuse with the dependency created in the first five practice models is promoting investment products with higher fees and commissions for higher corporate profits. Certain products, such as life insurance, variable annuities and limited partnerships, pay handsome commissions and fees to the financial advisor and their firm. With such a financial incentive – many advisors and their firms will “tailor” their financial planning advice and investment guidance, leading the consumer to believe these higher cost higher profit alternatives are the best solution for their financial problems. This practice lines their pockets while oftentimes picking your pockets clean!
Investment Banking Relationships – Take for example XYZ Company wanting to go public (a Wall Street machine revenue generator). Wall Street Firm A provides a channel to sell XYZ Company stock through their “financial advisors” (and other methods) to consumers. If Wall Street Firm A has an investment banking deal with XYZ Company, chances are even if XYZ Company is horribly run, unprofitable, and inefficient – they’re going to take XYZ Company public with an incentive for their stock analysts to be kind in rating XYZ Company stock. Granted, there is supposed to be a “Chinese Wall” between the investment banking side of a firm and the retail outlets and stock analysts – however with the inherent conflict of interest it’s naive to believe this doesn’t occur at some level.
Promoting proprietary or higher cost investment and insurance options to consumers is in all likelihood nothing more than an effort to increase personal and company profits. This holds true with many investment banking deals as well. 100% of consumers can benefit from low or no-load investment and insurance alternatives. If a financial advisor’s real underlying goal it to create a positive financial impact for their clients – why aren’t these firms and their financial advisors implementing financial plans using the lowest cost most efficient and effective alternatives? Certainly high costs and fees cannot be a pre-requisite for good performance and financial goal achievement!
A Registered Investment Advisor Firm with no broker-dealer association is the only financial services industry model where the entire compensation comes from the client only – not from the “Wall Street machine”. Those first five of six financial advisor models create an inherent dependence on behalf of their financial advisor employees directly to the company they work for. It’s unfortunate that only 5% of financial advisors are practicing in the form of a Registered Investment Advisor.