5 Huge Differences Between Fiduciaries And Brokers (part 2)

5 Huge Differences Between Fiduciaries And Brokers (part 2)

April 11, 2022

Fiduciaries and brokers aren't the same – in this continuation of our previous post, we explore three more key differences that you'll want to be aware of.

Broker: "So tell me. How do you feel about risk?"

Client: "I hate it. I hate risk. It scares the hell out of me. I'm afraid of what the market will do to decimate my finances, which I've worked my tail off to build."

Broker: "I think I have a product that you'll like. It largely avoids market volatility and all the risk that has your stomach in knots. Plus, it has a guaranteed rate of return you'll love."

Client: "Wow. Sounds great. Tell me more about it."

What you've just heard isn't investment advice. It's a sales pitch.

Take a closer look:

1. First, the broker lobs an easy question about risk (not many people like risk anyway, so the client's answer will be a no-brainer).

2. The risk question gets his client to open up emotionally, verbalizing the fear and loathing that the client has about risk.

3. That paves the way for the broker to steer his client toward a financial product that appears to offer the "dream answer" of little risk and volatility-proof.

4. He drops in a word like "guarantee" even though there really aren't guarantees.

5. All of the above moves the client toward jumping on board – with a product that, in reality, is the one that the broker makes the most commission on, which is no coincidence.

Fiduciaries can't take this approach to a financial relationship. Plain and simple. Fiduciaries have to work in your best interests first.

So if you view fiduciaries and brokers as the same, well, we're here to tell you they're usually not.

A person's designation as a "fiduciary" means big implications for the relationship. Those implications can include how you pay that professional, how much investment advice they can give you, and even the type of stock, bond, or mutual fund they may suggest you should add to your portfolio.

In other words, it makes all the difference in the world.

Building upon our previous post highlighting the chief differences between a fiduciary and a broker, let's look at three more key differentiators. This includes how each manages your investments, how each gets paid, and more.

3) Fiduciaries will select and manage investments for you. Brokers will take orders for you.

If you want someone to grant a degree of authority to manage an investment advisory account on your behalf, including choosing which stocks, bonds, mutual funds, and more to add to your portfolio, you want a true fiduciary advisor. A fiduciary does not require your consent on any trade (although you should definitely receive regular statements and trade information through a third-party custodian).

A broker cannot legally trade any assets in your portfolio without your consent. You must give them the order to do so first. No matter how much they may seem to manage your finances, if they have to run any kind of trade by you, that professional is a broker. Not a fiduciary.

4) Brokers are paid on commission. Fiduciaries are not.

Another real litmus test to understanding key differences between fiduciaries and brokers is to ask the financial professional sitting in front of you, "How are you compensated? Is it based on commission?"

Now, why would one care about compensation structure? What is crucial to the relationship other than how a professional receives pay?

A broker is paid on the sales commission of certain investments he sells as an incentive to push you toward that investment that he makes a commission on. Remember, the broker isn't obligated to advise you on the best investment since he isn't a fiduciary. In that event, the broker shouldn't be advising you at all. However, he can provide a lot of information on a particular stock in a not-so-subtle way.

The broker only has to meet the standard of suitability, which means as long as it's in the ballpark of what's appropriate, they may have several options to put in front of you.

In a structure where a broker could be compensated better for selling you on this investment over that one and the number of trades he makes, the door is certainly open for a broker to sway your decision toward the investment that can potentially compensate him the best.

Think about it: Which do you think a broker is more likely to persuade you to buy or sell – the investment he makes the most commission on or the one that he doesn't make nearly as much on?

You know the answer – it's probably the stock he makes the most commission on. If it happens to be the best for your portfolio, that may be a happy coincidence for him, especially when all it has to do to pass muster is be suitable for your goals.

Fiduciaries don't make money on commission from any investments you make. Not one cent. His compensation is typically based on the size of the account he's managing for you.

That matters because without that extra incentive – not to mention the fiduciary duty that must be legally adhered to – a fiduciary is free to recommend the best investment for your goals and make trades as necessary. So there's no extra motivation in incentivized compensation at work.

5) Only a fiduciary can be 100% independent as an advisor. A broker can't.

"Yes, I'm a broker but don't worry – I don't answer to anyone, so I'm independent."

That's only partially true. For example, a broker can be an independent contractor, but if he trades securities through a brokerage firm, he's not 100% independent. So while he can say that a firm doesn't employ him, he still may be receiving payment by a fund to be placed on a shortlist of investments to be recommended.

Consequently, the broker doesn't have a wide array of investment products to choose from. Suppose the above compensation structure is in place. In that case, he is confined to a select a number of investment options he can offer – and if he is receiving payment to provide those funds, his incentive to expand the list to other types of funds is small.

Does that sound independent to you?

Conversely, fiduciaries don't receive payment from a fund to be placed on a shortlist of recommended products. They can be potentially more flexible in their investment offerings because their designation places your interests first. They can approach your financial plan in the most objective manner possible. They are taking money from a fund that they later recommended would give the appearance of an improper relationship, thereby violating the Fiduciary Standard.

At Fiduciary Financial Partners, we act in your best interests while advising you on the mix of investments that match your needs. We're not paid on commission and have no fine print to hide on fees. It's a true fiduciary relationship in every sense.

With decades of experience, our team at FFP has been the go-to resource for investors who want to plan for retirement and for many years into it. So if you're ready to have a conversation with a fiduciary who does more than broker transactions, let's talk about our point of difference today at 630.780.1534 or click here to schedule a call.

Fiduciary Financial Partners, LLC is a Registered Investment Adviser. This blog is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Fiduciary Financial Partners, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Fiduciary Financial Partners, LLC unless a client service agreement is in place.