Investment advisor and financial advisor sound like similar titles. In fact, the term “financial advisor” is not a well-defined or regulated term in the financial industry. As a result, many people can call themselves “financial advisors.” Investment advisors perform many of the functions you would expect from a financial advisor: they work in the financial services industry and give advice on investments and securities in exchange for compensation. However, there are some key differences between an investment advisor and a financial advisor that consumers should understand when determining who they want working for them.
To address some of the confusion arising around these two terms, the U.S. Securities and Exchange Commission (SEC) has provided clarity. In the federal Investment Advisers Act of 1940 and in the state-level Uniform Securities Act, investment advisors are held to a fiduciary standard and are defined as investment advisors by meeting three requirements:
- One who gives advice on securities.
- One whose advice is given as part of their normal course of business.
- One who receives compensation in exchange for the advice given.
Financial advisors include financial planners, retail advisors, and commission- or product-focused advisors. These types of professionals must be licensed with a broker-dealer so that they can sell financial products (e.g., mutual funds, annuities, and other insurance products), and are not held to the fiduciary standard. That is, professionals who sell financial products are not considered investment advisors because they receive compensation for selling financial products in addition to advising clients.
Consumers should understand the incentives of those who give them financial advice and sell them products, and determine whether that affects the professional’s objectivity. Consumers find their interests more aligned with investment advisors because their fee structure rewards the advisor when their portfolio does well and reduces the advisor’s compensation when their portfolio underperforms. Financial advisors earn commissions from trades and from selling products, in addition to other fees, which are often paid regardless of portfolio performance.
The other key difference between the two professionals is the concept of a fiduciary standard. Investment advisors are held to this standard by law, whereas financial advisors are held to a suitability standard. What is the difference?
- The fiduciary standard is regulated by the SEC and maintains that investment advisors are bound to a standard that requires them to put their clients’ interests above their own. The law is written in specific detail and consists of a duty of loyalty and care. In other words, investment advisors must always act for their clients first before acting for themselves, must follow a “best execution standard” (meaning they must strive to trade securities at the lowest cost and in the most efficient manner), and must make sure all analysis is as thorough and complete as possible.
- The suitability standard is loosely defined as making recommendations that suit the best interests of the client, and only requires that the financial advisor (e.g., a broker-dealer) believes the recommendations are in the best interest of their clients. In adhering to this standard, broker-dealers can sell products that help their own bottom line and that also benefit their clients.
The key to finding the best resource and guidance is to find the professional who is the right fit for you. Some people may appreciate the simplicity of purchasing a financial product, such as an annuity from a broker-dealer, that provides the financial security they have been seeking. Others may value the thorough analysis, objectivity, and regulated standards that come with an investment advisor’s service offering. It pays to be painstaking in your search for an investment professional and consumers will benefit by starting their search with an understanding of the different professionals in the industry.