The Investment Scientist

Do you know your financial advisor?

Posted on: February 17, 2010

Few people know that there are 2,613,000 financial advisors in the U.S. It is the fifth largest vocation, right after truck drivers and before janitors. Even fewer people know that, unlike attorney and CPA, financial advisor is a free title – there is no uniform legal standard or educational requirement for the title. Nobody will get into trouble calling himself or herself a financial advisor.

In practice, there are two types of professionals who call themselves financial advisors: registered representatives (aka brokers) and registered investment advisors (aka RIAs).

Brokers usually work for big banks and brokerages, though some work for independent broker/dealers. They are licensed to sell financial products; legally they are not supposed to give investment advice except incidental to the products they are selling. That doesn’t stop them from calling themselves financial advisors since the title confers an aura of objectivity that the term “broker” does not.

Brokers usually get paid a share (40%) of the commissions and sales kickbacks like mutual fund loads they generate for the bank (brokerage). Needless to say, this pay structure creates a conflict of interest with their customers. In addition, legally they are not required to disclose how they get paid, so their customers are often left in the dark about the conflict of interest.

RIAs are licensed to give investment advice. They are usually paid a fee directly by their clients. The fee can take the form of an asset management fee, a project fee, or an hourly fee, all of which by law they must disclose in advance. These pay structures are not without conflict of interest, but the conflict is far less severe than for the opaque commission pay structure. To distinguish themselves from brokers, many RIAs call themselves “fee-only” financial advisors.

Then there are some financial advisors who are smarter than the rest. They figure they can have their cake and eat it too by dually registering as brokers and RIAs. They can then charge a fee for giving advice, and they can also sell financial products for commission based on that advice. They usually call themselves “fee-based” financial advisors. The public thinks they are the same as “fee-only” financial advisors, but they clearly are not.

I don’t know about you, but if I need financial advice, I want it to be from a fee-only RIA. How can you make sure your financial advisor is a fee-only RIA? Ask him to show you his FORM ADV Part II, the SEC mandated disclosure form for RIAs. Look at Item 1C, 7 and 8 of the form to make sure he does not engage in selling financial products for commissions. If your financial advisor cannot produce this form, he is either not an RIA or he has something to hide.

3 Responses to "Do you know your financial advisor?"

Very good summary of the “playing field”.

Beyond that, there are fiduciary advisers -who accept full fiduciary responsibility to act in the client’s best interest above their own…
and those who hold to a lower standard.


Great thoughts on brokers vs. RIAs, a great educational point that many do not realize. Do you think a certificate or designate endorsed by the AFAA in “due diligence” would be something you would promote?

There is definitely a general lack-of-awareness amongst the public, of financial advisors and planners and how they conduct business. properly researching financial advisors and understanding how they work is an important step in handling your personal finances.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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