What Makes a Financial Fdvisor “Independent”?

What makes a financial advisor “independent”?  What advantages do they have over “non-independent” advisors?

When I think about independence in the financial advisory space, my mind immediately goes to the ways that an advisor can work in the industry.  Although this is likely not the first thing that comes to mind when clients or prospects think about financial advisors, it is an important starting point when interviewing an advisor to potentially hire. The title “financial advisor” is ambiguous and, unfortunately, leads to even more confusion. It is my experience that the people I talk to often assume all financial advisors conduct business in the same way—it is based on their previous encounters with “financial advisors.”

Consider “advisors” that are holding themselves out to the public, as being on a spectrum. On one end there are “advisors” (I use quotation marks because the title is self-proclaimed and I wouldn’t consider them an advisor at all) that sell products. It may be an insurance salesman(woman) that sells life insurance, annuities, home and/or auto insurance, etc. that should really be called, at best, an insurance broker.

The definition of a broker is “a person who buys or sells goods or assets for others.”

In this case, the person is selling insurance products on behalf of an insurance company. In return, the person buying the product pays the insurance company for the product and the company then pays the broker a commission for the sale. There isn’t any advice going on this scenario (there may be some ancillary advice on product features, or which product may be the most suitable given the limited choices available—but that’s it). I certainly wouldn’t classify this group as an “advisor.”

The next group in my spectrum is a securities broker. Again, this is a person who sells goods or assets for others; this time they are selling stocks, bonds, mutual funds, etc. on behalf of those companies and in return they are receiving a commission. This is where it starts to get a little more unclear because we like to believe that people who are offering investments are providing “advice” and so it is easy to start considering them an “advisor.” Unfortunately, there is not a legal expectation that a broker is offering investment advice—in fact, if you read the legal disclosures, it is quite clear that they are prohibited from offering investment advice with this arrangement.

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In a spectrum, there isn’t a clear delineation between one group and the next, much like brackish water is the intermediary between fresh water in the rivers and salt water in the ocean.  It’s no different with this next group, that are known as dually registered (or hybrid) advisors. These “advisors” sometimes act on behalf of their broker dealer wearing their Registered Representative “hat,” and then other times act on behalf of clients as an Investment Advisor wearing the Investment Advisor Representative “hat.” The distinction here, as always, goes back to who pays them.  In some instances, they are earning a commission from their parent company, and in other instances, they are being paid directly from the client. Sheesh! How do you know which “hat” they are wearing, and when? And how do you know when they’ve moved from sitting next to you at the table representing your best interests to the other side where they are obligated to act in the best interest of their company?  It’s nearly impossible for a client to keep up.

Finally, on the other end of the spectrum, there are Investment Advisors that do not have a broker dealer affiliation and are only compensated by their clients. A very small percentage of financial advisors are truly fee-only professionals that do not collect commissions of any kind and are paid exclusively from their clients. There is never a question of who they are representing or how they are getting compensated. Additionally, there aren’t any product sales which could call into question potential conflicts of why one product was recommended over another.

Although there may be other categories of “advisors” that fall into gaps on the spectrum I just described, the majority of financial advisors will be in one of those categories.

So, what makes a financial advisor “independent”?  And what advantages do they have over “non-independent” advisors?

The advisor is independent when they are able to give investment advice without considering product quotas, higher commissions on certain sales/products, rewards trips, etc. The focus can be on providing the best advice during every interaction. The independent advisor has the advantage because they can remove many of the conflicts of interest that a “non-independent advisor” can. It is naïve to believe that all conflicts of interest can be removed, but independent means that the conflicts left to consider are between the advisor and the client without third party input. Depending on the compensation arrangement, it’s possible to still have a conflict using an AUM model (the greater the assets, the higher the fees paid to the advisor) or a flat fee model (work performed not compensatory to the fee received).

The independent advisor must still be vigilant in identifying conflicts of interest and addressing those with the client. The difference is the fees are transparent because the client can see what they are paying, and a conversation can be had and agreed upon up front before the parties engage. As I mentioned earlier, I have moved through this spectrum as my career progressed and landed in the Registered Investment Advisor (RIA) space because I believe the ability to serve clients best can be done when the relationship is built on transparency and common goals. The success of the client should be paramount in the attitude and actions of the financial advisor you choose.