Investment advisers vs. brokers: Know the difference Boomer Bucks by Barbara Whelehan Bankrate.com True or false: Financial planner, financial consultant, investment adviser, stockbroker -- these are all titles for people who provide essentially the same types of services, right? True. So there's no need to concern yourself about how they differ from one another, right? False. Actually, there's a wide chasm between brokers and investment advisers, though you can hardly tell if you just go by their titles. That's because in recent years, brokers have been recasting themselves as financial consultants, offering a slew of wealth advisory and financial planning services, on top of their usual job of buying and selling securities. "Many would claim that the brokerage industry deliberately makes this differentiation difficult for the public by using such labels as 'financial adviser' and 'financial consultant' for a role once called 'stockbroker,'" says Michael Kitces, a certified financial planner and director of financial planning for Pinnacle Advisory Group in Columbia, Md. The difference is legal Brokers are held to a different standard than registered investment advisers. The latter must abide by the rules of the Investment Advisers Act of 1940, which legally obligates them to act solely in the best interests of their clients. Brokers, meanwhile, are regulated by the National Association of Securities Dealers, which imposes a "suitability standard" rather than the stricter fiduciary standard. This simply means an investment sold by a broker must be suitable for the client. Critics say the standard is loose and allows brokers wide latitude in recommending products that often serve the brokers' interests as much as or even more than those of their clients. Proponents say the NASD rules are just as stringent as the SEC's, so brokers shouldn't be subject to duplicative regulation. Earlier this month, the Securities and Exchange Commission overwhelmingly approved a 1999 proposal that officially allows brokerage firms offering fee-based accounts to be exempt from registration and regulation as investment advisers. The controversial decision drew approval from key congressmen on the House Financial Services Committee, but the ire of financial planners who say brokers continue to have an unfair advantage by selling "lots of services with minimal liability," in Kitces' words. A bit of background The SEC's ruling that exempts brokers from registering as advisers actually upholds the law as stated in the Investment Advisers Act of 1940. Brokers were exempted 65 years ago in part because they were regulated under provisions of the Exchange Act, enacted in 1934. So why resurrect this ruling? The SEC initiated the proposal in 1999 in response to changes in the market place, in particular the introduction of fee-based brokerage programs, which changed the way in which brokers were compensated for their services. Until fee-based programs came along, transaction fees made up the bulk of brokers' businesses. Last summer, the Financial Planners Association filed suit against the SEC because even though the 1999 proposal had not been approved, the brokerage industry was conducting business as though it had. The lawsuit was put on hold while the SEC gathered public comments on its proposal. In the end, the SEC concluded that the fee-based programs were not "fundamentally different from traditional brokerage programs," and in fact afforded "important benefits to brokerage customers." The fact that the programs generated asset-based fees of between 1 percent and 2 percent rather than transaction-based fees alleviated concerns the SEC had "about the incentives that commission-based compensation provides to churn accounts, recommend unsuitable securities and engage in aggressive marketing of brokerage services." So these changes in the brokerage business represent a win-win for brokers and consumers alike, in the rose-colored analysis of those in the securities industry. It's an especially big win for brokerage firms, which have attracted nearly $269 billion of assets into fee-based accounts, double the amount five years ago, according to Boston research firm Cerulli Associates. That's not to say that the SEC is unconcerned about the trouble consumers have in distinguishing between investment advisers and brokers. To that end, the SEC will require brokerage firms to disclose in plain English that they offer brokerage accounts -- not advisory accounts -- and also the fact that brokers' interests may not be the same as those of clients. Will consumers recognize these red-flag statements and run? Probably not. In sheep's clothing My educated, intelligent friend Pam learned the hard way about how divergent such interests can be. She opened an account with a broker in the mid-1990s, during one of those downdrafts in the midst of a roaring bull market. She's a trusting soul, so she went along with her broker's recommendations. Within three months he decimated her account, shorting stocks that went up, going long on stocks that crashed, until it became a mere shadow of its former self. He was slick, came up with reasons for the failures, kept offering solutions to get the money back. She closed the account after losing 90 percent of her assets. Another friend, Tom, once worked for a small full-service brokerage firm in New Jersey. He now works for a discount broker that hires certified financial planners and does business with investment advisers, and says the difference in the way clients are treated is stark. He explains that when you see a broker, you normally fill out an application, outlining general parameters, such as your income, risk tolerance and investment goals. Armed with this information, a broker still has a wide range of flexibility with what he or she can sell you. "They can't do something egregious. If an investor is conservative, they probably wouldn't push penny stocks on him. Most wouldn't do that. But there's a lot of gray area in the middle where a disservice could be done to a customer." Pressure to sell vs. option to sue For example, brokers may be pressured to sell particular products, and whether these products are appropriate for their clients is open to interpretation. "You get better incentives, better commissions on some mutual funds than on others, and that could cloud someone's recommendations a little bit." Meanwhile, Tom says, investment advisers must be upfront about what they do. "There's a lot more two-way communication before any advice is given at all. Their guidelines are lot more strict. Brokers are held to less account. It's not necessarily their fault, just a result of their pay structure. They get focused on selling product and not seeing the bigger picture." So the main difference is that brokers are under pressure to sell (the top producers are in big demand), while advisers are obligated by law to serve your best interests. Of course, that's not to say that all brokers are ruthless, or that all investment advisers are ethical. Any financial professional can break the rules and do a disservice to the consumer. But if you get into a dispute with an adviser, you can sue. With a broker, you have no choice but to settle the matter in an arbitration hearing. Investors waive their rights to sue thanks to standard clauses in their brokerage account contracts. Brokerages in the news In recent months we've seen the SEC and the NASD take action against brokerage firms for a wide range of misconduct. Some of it had to do with cozy revenue-sharing agreements between mutual fund companies and brokers who push their funds. Some of it had to do with brokers selling inappropriate (meaning more expensive) share classes of funds to investors. Citigroup, American Express, Edward D. Jones & Co., and J.P. Morgan Chase were among firms paying fines to settle such charges. Of course, as is standard practice, none of these companies admitted or denied wrongdoing. SEC chairman William Donaldson has publicly stated that the agency continually strives to inform investors about broker conflicts and compensation. I hope that message will seep through to consumers. Longtime financial journalist Barbara Mlotek Whelehan earned a certificate of specialization in financial planning. -- Posted: April 27, 2005

Carol, I found your post a few weeks ago on a search. For some reason, I keep thinking about your questions and the advice you got, and I finally decided to log on and comment. Here are a few comments about your post: 1) You make a good point about being able to get better returns with mutual funds over a MM. 2-3% is very achievable. On the other hand, it is also quite possible to lose 2-3% - or more- with mutual funds. This is the trade-off between risk and reward that is inherent in investing. Typically fixed income investments, such as MM, T-bills, and government bonds are called "risk free" investments. Equities, such as stocks, and stock mutual funds are typically considered to be riskier. In general, the "riskier" the investment, the higher the rate of return. 2) You mentioned investing in a mutual fund. Another aspect of risk/reward is diversification. Again, in general funds that are spread among several different investments are at lower risk (Dont put all your eggs in one basket). Taking this a step further, risk is reduced more by making sure the different investments are sufficiently diverse. Some examples of diversity would be bonds vs. stocks, growth stocks vs. value stocks, US stocks vs. foreign stocks, etc. 3) Everybody has a different risk tolerance. Your husband seems to be very risk averse. You seem to be more risk tolerant. The level of risk is a personal decision that both of you must feel comfortable with. 4) I would like to suggest that you visit a website called www.ifa.com. This is a company of investment advisors that specialize in mutual funds by Dimensional Fund Advisors (DFA). IÂm not suggesting you use DFA at this time. What I am suggesting is that you and your husband take the risk survey that IFA has on their website. It is free, and you donÂt have to sign up or give them your E-mail address. The risk survey is about 20 questions. The results give you an idea where you are on the risk taking spectrum. Based on the results, IFA will suggest one of 20 different portfolios that fit in with your risk tolerance. Again, I wouldnÂt necessarily suggest those portfolios for you, but they will give you a general idea of the types of investments that would be consistent with the level of risk you and your husband would like to take. I may make a few people angry, but I need to comment about the advice you have been given: First, the good advice. 1) I agree with much of what jkom51 says in the first reply. Although you probably donÂt need a CFP, it wonÂt hurt as long as you can find a good one. 2) Chisue suggested treasuries and CDs. These can be good alternatives to MM, but you should research the advantages and differences. 3) Great advice f lphacat. American Funds are "load funds". That means when you buy them, a salesman gets a commission, usually about 5.25%. If you invest $400,000, you will LOSE $21,000 immediately. The big problem with this is that there are "no load" funds out there that will do just as good if not better, and you can get them for about $30 per fund. If you have 10 funds, that would be $300 verses $21,000. Too often an advisor who is recommending a load fund has his best interests at heart instead of yours. I wouldnÂt even consider load funds if I were you. 4) Alphacat also suggested DFA funds. He is correct; almost any DFA fund runs rings around American. They are all no load and have much lower annual fees as well. On a $400,000 investment, the difference in ER between DFA and American can run $4000 per year. With compounding, this is about $60,000 over 10 years that you are giving up. 5) The absolute best advice you got was f lphacat when he recommended you go to www.fundadvice.com. Go there and read every article, especially this one (sorry, I canÂt get the link to work, so I just copied the whole address) http://www.fundadvice.com/articles/buy-hold/the-ultimate-buy-and-hold-strategy.html. Paul Merriman gives great advice to folks. He is also a financial advisor who you might want to consider. I think he will work on a percentage of assets or I know he will give advice on a per hour basis (around $200/hr). This may be your best option. For about $400 you can get some really first rate advice on how best to invest. For disclosure purposes, I donÂt invest with Merriman, but I do read his site quite often. Also, for disclosure, all my IRA assets are invested in DFA funds. Now for the bad advice: 1) The average investor has absolutely no business investing in individual stocks. If you put your money in 10 mutual funds you are invested in 10,000 stocks. Now if one of your stocks goes bankrupt, would you rather lose $40,000 ($400,000/10 stocks) or $4 ($400,000/10,000 stocks). This goes back to diversification. You just canÂt minimize the risk enough with individual stocks. 2) DonÂt bother going to Morningstar.com, or Forbes, or Money . Frankly I consider most of what they put out to be financial ography. They are trying to entice and tempt you with the "hot" stock, the " " stock, the investment that will make you filthy rich. But if you go back and look at last yearÂs "hottie" chances are it is a dog this year. For now, read everything you can at fundadvice.com. Another good site is www.diehards.org. That is a forum primarily by index investors. Go there and post the same message you put on this web, and you will get some fantastic advice (much better than I can give you). Just a few more comments. 1) The best portfolio for you and your husband will probably be one that includes MM, bond funds, and stock funds. Again, your risk tolerance will determine the best portfolio for you. 2) One more article at fundadvice.com is this one. http://www.fundadvice.com/portfolio.html Merriman provides several suggested portfolios with different fund families such as Vanguard and Fidelity. Most of these funds are index funds. Some are managed funds, but all are no load with low fees. 3) Many people prefer index funds. These funds track an index such as the S&P 500 or others. They typically have lower fees than managed funds and studies show that managed fund usually underperform index funds over the long term. You can get a good explanation of this at fundadvice.com 4) You asked for a few good funds. Several are listed in the site referenced in #2 above. 5) Good luck with your investment . Jeff

Chisue - As the person in charge of our family's investments, I say yes, go ahead and buy into an index fund. With your already good diversification and common sense and understanding of the portfolio you already own, and with your children established, you are in an excellent position to do this. You do not need any detailed understanding of how the market works to invest in something as simple as an index fund. 23 years ago I invested in Vanguard's Index 500 fund and our investment has quadrupled over that time despite some pretty significant dips. I have withdrawn a small amount of money perhaps 4 - 5 times over the duration, when I didn't want to touch cash or our IRAs. The taxes and expenses on index funds are extremely low, another reason they are so attracitve. Despite all this, four times my original investment makes me happy! Just to establish my street cred. DH and I are nearing your age group and have similar concerns. Our children are grown and gone and on their own (and I do like to gift them with cash occasionally), so we are mainly involved with concerns of retirement right now, plus health issues, travel expenses, etc. We are in a fairly good situation and we have never used a financial advisor (although we've had good discussions with our accountant). I saw what "advisors" did to my mother. No thanks. Here's another thought: Money gurus recommend that senior citizens keep some money in stocks. People are living longer and need the financial growth that stocks provide, even if they don't plan to touch the money. I would suggest an Index 500 fund. This invests in the 500 largest companies in the USA, although sometimes fewer than 500 stocks are held. That really doesn't matter. Some recommend a total market index fund, which holds every domestic stock (more or less). I like the index 500, it follows the DOW (our 40 largest companies) pretty closely, so when I check CNBC I know pretty much where this particular investment is. I would do the Index 500, because it's so easy to understand. I would not invest outside the USA right now. I have held a little money in an international fund for almost 20 years, a good fund from a solid brokerage (T. Rowe Price), and it has barely doubled in that time. You can also ask the agent if a small cap index fund would be good now. It might be good to put most in the 500 and some in a small cap. But remember - these brokerage houses - Vanguard, Fidelity, etc., - are BY LAW not allowed to give you advice. They can only explain, very thoroughly, but they cannot tell you what you should do. There is no charge for your conversations with them, and they may not give you advice. Maybe a few little suggestions, but nothing that you could hold the company accountable for. Any time is the best time to invest. Get In and Stay In. Do not panic. I have always withheld a modest amount of money in case of severe crashes, so that I could buy a bit more on a serious dip, but I never bought a lot more, because I try not to market-time. One can go crazy trying to time the market! Fidelity has a great story about this. The market crashed badly in 1989-1990, just before the first Gulf War. Fidelity's people were innudated with calls from panicked customers. One of them answered a call and there was an elderly gentleman on the line. He was apparently not aware of the crash. He said that he had put a bit of money into the Fido's first mutual fund many years before and was wondering what it was worth. The callperson looked at his chart and saw how much that fund had just lost, but also, that it was up tremendously from his initial investment. "$300,000" she replied, worried about his reaction. "Yippee!" he yelled, and hung up. It's all a matter of perspective. Anyway, sorry for blathering on. How you do this: Call Vanguard from its online number and tell them that you want to invest in a mutual fund. They will transfer you to one of their agents. It is so simple. He will explain what to do and tell you that he will send you the forms. When they arrive, you fill them out, write the check and send it all in. Or you can probably do this over the phone if you have the money in a checking account, which can be linked to your Vanguard account. You can also do everything online with a linked account, but am not sure if that's possible for an initial investment. It would probably be good for you to talk to an actual human being on your first visit. These people are very accommodating! They are used to dealing with all kinds of people, of any age, any language ability, crabby, pleasant, whatever. Apologies for the lecture. I hope it helps. If you have any questions for me, I usually go to the Home Decor Conversations forum a few times a day. I might forget that I've been here. So give me a shout-out over there if necessary. And good luck. You are thinking very wisely.

As for "80% of stock funds underperform the S&P500 so you'd have to make a strong argument for how a custom portfolio will do any better." This is far from true. Just as a for instance, if you bought a S+P 500 index fund, its performance would be EXACTLY the same as that index it was mirroring, adjusted for costs. Elmer, I believe you misunderstood me. Of course stock *index* funds perform the same as the index they are mirroring. I was talking about nonindex stock funds like mutual funds that are managed. They often underperform the stock indexes. From investopedia: Generally, when you look at mutual fund performance over the long run, you can see a trend of actively-managed funds underperforming the S&P 500 index. A common statistic is that the S&P 500 outperforms 80% of mutual funds. While this statistic is true in some years, it's not always the case. A better comparison is provided by Burton Malkiel, the man who popularized efficient market theory in A Random Walk Down Wall Street. The 1999 edition of his book begins by comparing a $10,000 investment in the S&P 500 index fund to the same amount in the average actively-managed mutual fund. From the start of 1969 through June 30, 1998, the index investor was ahead by almost $140,000: her original $10,000 increased 31-times to $311,000, while the active-fund investor ended up with only $171,950.