Do Your Hiring Homework: Learn the Differences Between Brokers and Advisers

If you asked the average person on the street if there’s a difference between a financial adviser and a broker, most would tell you they’re one and the same.

Somehow, though, over the past few years, the words have become synonymous. And that is 100% wrong.

You’d think with all the money involved, investors would be clearer on the roles and responsibilities of their financial professionals. Instead, they too often hand over their life savings to the person who promises the best returns.

Here are just some of the differences:

An adviser, or, more specifically, a Registered Investment Adviser, is held to the “fiduciary standard.” He offers impartial guidance and puts his client’s best interests ahead of his own. His compensation is usually fee-based; he might get paid per hour or service, but most likely he’ll get a percentage of your portfolio — say 0.25% per quarter, or 1% annually.

A broker, in most cases, sells products and makes trades happen. He is held to a “suitability standard,” which means he must provide options that suit the client’s needs, but those choices might not be the least expensive or the best match for the client’s goals.

A broker’s compensation is commission-based. If he invests your money into a stock, for example, he might get 5% on the front end. If the stock goes up, great. But if it goes down, he’s already been paid. And he’ll make money again when he sells you on the next thing.

There are pluses and minuses to both arrangements. A broker, for example, can often provide valuable insights and advice about the market.

But if you want a financial professional who’s truly looking out for you long-term, remember: A fee-based adviser is actually paid on performance. He makes more money when you make more money.

So, for example, if a client invests $250,000, and the adviser helps double that to $500,000, he doubles his income as well.

As a fiduciary, he’s helping select investments that best meet his clients’ risk tolerance and achieve their financial goals — not the products that come with the highest compensation on the front end or that his boss wants him to push, as a broker might do.

To take it a step further, let’s look at some of the other costs that can come with working with a broker.

If you’re in the retail world of investing — if you’re just a common investor who is working with one of the big brokerage houses out there — you’re likely paying some costs that you aren’t even aware of.

Let’s say you’re a do-it-yourselfer and you decide to invest in a bunch of mutual funds. Your “expense ratio” could be made up of several fees: an administration fee that could range from 0.2% to 0.4% annually, an asset management fee that could be anywhere from 0.5% to 1%, a 12b-1 annual marketing or distribution fee, etc.

Put them together, and add in trading costs that could be another 1%, and you easily could be paying 2% to 4% and not even know it.

Contrast that with the institutional side, where you’re working with a licensed financial adviser who is a fiduciary. Your “wrap fee” will essentially encompass all costs, including the adviser’s fee, the institutional money managers who actively oversee the account and unlimited trading costs. You won’t be nickeled-and-dimed every time there’s a purchase or sale.

And all those savings could have the potential to turn into better returns — which is the goal, right?

It’s difficult enough to know who to trust with your hard-earned savings without all the confusion over terms, fees and compensation.

Make sure you stay schooled in the vocabulary and the math required to make smart investment decisions. Your future self will thank you.

Kim Franke-Folstad contributed to this article.