February 2024
Priscilla and Chris encourage listeners to understand how compensation works when choosing between an RIA and brokerage firms, as brokerages often compensate their advisors based on transactions, which can lead to potential conflicts of interest. On the other hand, RIAs are generally compensated through a fee structure, which may align the advisor’s incentives more closely with the client’s success. Furthermore, listeners should understand the investment philosophy of the advisor, whether the advisor requires the client’s approval for every transaction, and whether the advisor acts as a fiduciary since fiduciaries are legally obligated to put their clients’ interest ahead of their own.
Watch previous episodes here:
Ep. 72 Highs & Hazards: Market Surges and Banking Risks
Ep. 71 What a Resilient Investment Portfolio Means to Us
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host Chris Galeski, joined by Wealth Advisor Priscilla Brehm. Thank you for joining us.
My pleasure.
We're going to talk today about the difference between a brokerage firm and a registered investment advisory company like Morton. So in our area, I think that there's a lot of confusion out there, not only with which investments do I choose, what do I do, but also what's the difference between Company A and company B? So I thought we might want to talk to our clients a little bit about the differences between those two models.
Now, not everybody is hiring a financial advisor. Some people might want to do it themselves and there's all sorts of studies that say very interesting things when it comes to making decisions by yourself.
I did some Googling. I thought, well, what if I were I wanted to be a successful investor, but I wanted to work on my own. I felt that I could do that. You know, I'm a good user of the Internet, right? So I put in my search bar: what is a good investment right now? And I got 3.2 billion hits.
And then I realized if I were a successful investor working on my own, I really wouldn't know where to start.
There's so many different things to invest in and then so many different companies to invest with. Yeah, it can be confusing or not really clear who you're talking to and where they're incentivized necessarily.
So the key part of today is to talk about the differences between the brokerage firm in the RIA model. But then at the end, we're going to share a few questions that people can use to ask the person that they may be interviewing for advice or insight to kind of see where those conflicts may arise. Sound good?
Exactly.
Well, one of the reasons why I'm excited to talk to you about this topic is you've been in the industry for a couple of years, but you used to be a chief compliance officer.
So as a chief compliance officer of a registered investment advisory firm where you're forced to be a fiduciary, tell me a little bit about like the regulatory side of things versus the human side of things.
Well, that really brings up, I think, one of the key differences between an RIA or registered investment advisor and a broker dealer, and that is the standard of care. So as the chief compliance officer of an RIA, I had to make sure that we were acting in our capacity as a fiduciary. So basically a fiduciary is someone who must always put your best interests above their own.
And so we spend a lot of time thinking about what that meant. We spent a lot of time making notes about conversations, making sure that we understood each and every client and how they were different, and that what we were doing was always without fail in their best interest. And that's very different from the broker dealer model. And it's not that broker dealers are bad.
Right. Not bad. Just different.
Just different. Yeah. Because their standard of care is that an investment that they sell you has to be suitable. Yeah. And it has to be suitable to your specific situation. So in other words, if you're, you know, elderly and you need income, they need to make sure that any investments they sell, you meet that specific situation. Yeah, right.
But that doesn't mean that they have to find for example, they maybe they will sell you a mutual fund that produces income, probably invests in bonds, but they might sell you a mutual fund that has a higher commission that's suitable, but it's maybe not in your best interest.
And, you know, I think that that's one of the things that was surprising to me. Look, I've been in the industry for 15 years, so still relatively young, although today we're seeing some things in the market that have never happened before. But early on in my career, it became very apparent that when I was working for Morgan Stanley that we operated on the suitability standard or the best interest on contract.
And I was in a meeting with my manager at the time. I'm not going to throw anybody under the bus. And volatile times 2009, 2010, coming out of the great Recession, there were these things called structured products or structured notes. They were designed to limit some of the upside but protect you on the downside.
And they said, you're registered, you're licensed, go sell this. I mean, God forbid somebody read the entire booklet. I couldn't even tell you everything about it. I didn't feel comfortable just going and selling it. But what I was told is, hey, people that want protection from the downside and are willing to give up some of the upside, this is great for them because they just lived through the financial crisis and people don't want to lose money, so go sell it.
That was a clear example of, you know, finding people that this would be suitable for versus finding people that, you know, this makes sense for them, right?
Well, that really points to the fact that broker dealers are compensated when they execute transactions. Yeah, that's that's in the official description of a broker dealer dealer. They execute transactions on behalf of a client. You know, actually, they call them customers. And if you don't buy or sell the broker dealer doesn't get paid. And they can provide investment research and some information.
But technically, a registered representative of a broker dealer is not allowed to call themselves an investment adviser. And and that, I think, is an important distinction. They can call themselves a financial advisor.
But not an investment.
Yeah. So in your situation, when you were told to go sell this thing. Yes. Structured product, you were executing your responsibility to your broker dealer. That's your primary role, your primary responsibility and you should have been told to find customers who were suitable for it.
Definitely. And my title at the time was Financial Advisor Associate. If that helps bring credibility, even more credibility. I was in the training program like I was brand new. But you, you have a story that goes back to when you were first in this business and creating financial plans. You know, tell me a little bit about that.
This was pre Morton. Yeah. And this was pre the time when I had my own financial planning firm. I was working for a company that primarily sold life insurance. But we had identified a need with their customer base. They needed financial plans. And so I created a financial planning service for them. I really was excited about this because I thought, how important is this, you know, for somebody to have a financial plan and I really was disappointed when some of my financial plans were rejected by the management or the salespeople because I didn't recommend enough life insurance, and that was really how they made their money.
Yeah. So it was kind of an eye opening experience for me.
And that was in and to your point, being eye opening, that was one of the first times where you sat there and say, Look, I'm just trying to give the best advice possible.
Exactly.
I'm now seeing a conflict. You eventually made your way over to Morton and you came here because that conflict was removed.
Yeah. After this experience, I did start my own financial planning firm and I said, I'm never, never, never, ever going to do something that is not in the best interest of my clients. I owe them that. Right.
We do. And I say this. I say this sometimes it's not our job to put our values around somebody else's money, right? It's our job to truly understand who they are, what they're trying to accomplish, where they're trying to go and help facilitate that journey. The best way possible.
Exactly. Exactly. You tell me what you want and let's figure out how to get you it.
So you left. You were adamant that. You know what? I'm not going to have any conflicts of interest. You started your own firm, and then you met Lon, who had started this investment advisory firm. No conflicts fee, only fiduciary back in 1982, Right?
Yeah, right. He had started his firm in 82. I had started my financial planning practice in 1984. And I met him again in the 1980s and we sort of traded referrals back and forth. Right. And in 1988, he finally convinced me to join the firm full time. So and the rest, as they say, is history.
Intent tends to work out that way. Now the regulations. So brokerage regulations, they they might have a different viewpoint in terms of the regulations that they might put in place for a particular investment. And it might surprise you on what some of these, you know, standard regulations or pushback might be. I laughed when you were sharing me this example of looking into an investment and saying, No, I think you need to adjust the font size or you know how this is laid out.
It's not really the investment itself, but it's how it's being marketed.
Yeah, the FINRA spends a lot of time issuing regulations, some of which literally have to do with the font size on a business card. And I'm just not sure that that's really what an investor needs to be successful. I think what you need to be successful is someone who has your best interest, who understands your aims, who will help you achieve your life goals.
Yeah. And, you know, when you're when you're working with a broker dealer because they are paid for transactions, it's probably going to be a transactional relationship.
If there's nothing to buy or sell, there's nothing to talk about. Yeah. Right. Whereas with an RIA, because we're not compensated based on the transactions. We're paid for our advice. It's it's a very, very different relationship.
Yeah. And so if you're a new investor or you're someone that's going out there and interviewing somebody to be your financial advisor or your investment advisor, what are some questions that you would want to make sure to tell your younger self or other people? Here's the questions that you should ask the person that you're interviewing.
Well, I think one of the first questions to ask is how are you paid? And we gave the example that a broker dealer or a registered representative is paid based on transactions, whereas an RIAA will either be paid an hourly fee. Normally an RIAA is paid as a percent of assets under management. And so understanding how someone is paid is is a good starting point.
A second question I ask about the standard of care. Are you a fiduciary?
And an RIA will say, Yes, they are. And a registered rep will say no.
I love the fact that you called it out right of the forefront. I think it's important that people ask their advisor, the person that they're interviewing. Are you a fiduciary or do you operate in what's suitable in a best interest contact? Because there's some interesting, I guess, conflicts of interest that can arise. You can be a certified financial planner and supposed to be held at a fiduciary standard, but working for a broker dealer where you're incentivized in other ways, people should know and understand that.
Absolutely. Yeah. A registered rep has a primary duty to their employer, to their broker dealer, and and someone working for an RIA. Their primary duty is to the client. So that's kind of an important difference, because as a registered rep, your job is to do what the broker dealer tells you needs to get done. Right. So if there's excess inventory, you know, maybe some bonds that need to get moved out of the broker dealers inventory.
That's your job.
I think another question to ask is what kind of services do you offer? And are there additional fees for those services? Yeah. And then I think it's really important to have a conversation about investment philosophy. What's the philosophy of the firm?
You know, what kind of asset classes? How do you determine what asset classes I should be invested in and see what how that conversation evolves. That'll be a very interesting conversation.
I like that one. I often find that in conversations with clients that, you know, come to us from somewhere else and they're not happy with performance or investments or the way things, you know, shook out from time to time. It's often because they're not aware of the investment philosophy of the people that they were investing with and whether or not it aligned with them.
There's a mismatch of expectations. Yeah, from time to time. Yeah. And oftentimes someone's success when it comes to investing is how they respond or react during good or bad times. Exactly. And having that understanding with the people that you're working with and being on the same page with how to best respond or react during good and bad times will make sure that you have a partnership that's truly going to help you get better returns and stay invested long term.
And look, we're not right for everybody, but you know, you should know that when the markets go down, we're not going to say sell and go to cash. No, In fact, we might actually knock on your door and say maybe we might need to buy. Yeah. And if that doesn't sit well with you or that's not the way you would want to react, then you need to find somebody that would respond differently.
Right. Right. I think, Chris, another difference that you will usually find between a broker dealer and an RIAA is discretion. In other words, a broker dealer, except in very, very limited circumstances, cannot buy or sell anything in your portfolio without your specific authorization. Whereas in an RIA, we will normally take discretion. Now that discretion is within the confines of, you know, all of the things that you've talked about, your goals, your time horizon, your risk tolerance, etc..
But that's another question that I think is important to ask, is do you execute trades on a discretionary basis?
Yeah, we've seen some interesting situations where, you know, people own individual bonds and, you know, they're saying, I don't pay a fee for, you know, me to own that. But then you can look up the data and you find out that there was a 3% commission to buy, you know, some of these things that at the time were yielding two and a half or 3%.
Look, we've talked about a lot today, but mainly the differences between a brokerage firm and a registered investment advisory firm. And really the difference between being a fiduciary and then operating through the form of what's suitable or a best interest contract. I love the advice that you gave in terms of understanding the conflicts of interests, the philosophy behind the people that you're working with, and whether or not they're truly a fiduciary as you're trying to find a partner to help you reach your long term goals.
It's so important to have a relationship where you're on the same page with some of those core things in order for people to be successful, especially around decisions, around money. So thank you so much for your time today.
Disclosure: Information and references to specific investments presented herein are for illustrative purposes only and subject to change without notice. It is not intended asinvestment advice and should not be construed as an offer or solicitation withrespect to the purchase of any security. Investment opportunities described mayonly be available to eligible clients and involves a higher degree of risk.Each investment opportunity is unique, and it is not known whether the same orsimilar type of opportunity will be available. Morton makes no representationsas to the actual composition or performance of any security. Morton Capital is an SECregistered investment adviser; however, such registration does not imply anylevel of skill or knowledge. There is risk of loss investing in securities,including the loss of principal amount invested. Past performance is no guarantee of future results.There is no guarantee that the investment objective will beachieved. Morton Wealth makes no representation that the strategies describedare suitable or appropriate for any person and should not be assumed thatMorton will make investment recommendations in the future that are consistentwith the views expressed herein. You should consult with your financial advisorto thoroughly review all information before implementing any transactionsand/or strategies concerning your finances. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change
