There are a few standard sales or distribution models employed by the Broker-Dealer and Investment industries. Each model compensates the broker or planner in a different manner. Though most still incent the broker/advisor to seek out investors with larger amounts to invest. You may notice that we refer to either a Broker or Planner (Investment Advisor) uniquely. That is because, historically they have been unique in their duties, qualifications and compensation schemes.
THE BROKER MODEL
Broker’s work for Broker-Dealer firms as registered with the Securities and Exchange Commission under the 1934 Act and regulated by FINRA. They typically receive a commission (cost to you)
when they sell an investment product (stock, bond, exchange traded fund, mutual fund, or other). They may make recommendations of products for your purchase/investment, or they may simply take your order and execute a trade on your behalf. Broker’s must typically be registered with FINRA and pass examinations to obtain licenses in order to sell investment products. The investment products sold by Broker’s may have an additional lesser, recurring commission that pays them a small percentage of the amount you have invested for a few years after your make your initial investment. HOWEVER, this is typically a very small amount and does not provide a large incentive to continue to service and advise you. Unless, of course, you have more money to invest and can generate additional commissions for the broker. In the past, some broker’s were allowed to manage investments in a “wrap” account and forgo upfront commissions (costs to you) for an ongoing annual or quarterly fee based on the amount of money you have invested. The fee charged typically varied from .5% to 2.0% based on a sliding scale of the amount invested. Additionally, the 1934 Act does not currently hold a broker to the same Fiduciary duties required by Investment Advisors under the Investment Advisors Act. Historically, broker’s have not had to make recommendations that were in your best interest, just those that were suitable for an investor with your experience. (More on dealing with Brokers)
THE INVESTMENT ADVISOR MODEL
Investment Advisors must register with either the U.S. Securities & Exchange Commission (SEC) or their State Securities Board. Investment Advisors have a Fiduciary duty to suggest financial plans and investments that are in your best interest, regardless of conflicts with their best interest. Investment Advisors may charge a flat fee (in dollars) for providing a service such as generating a specific financial plan(paper or electronic document). In addition, they may charge a percentage fee to manage money that you invest. Typically these fees are similar to those described in the Broker Model (.5%-2.0%). Or, they may perform both. However, each scenario should require a separate and new advisory agreement. One for the plan, and another for the ongoing investment advice. Some Investment Advisors perform investment management and execute trades on your behalf, but keep your funds(assets) with a custodian. Therefore, the advisor will instruct the custodian on how to invest your money, but the advisor does not have direct access to your funds. The custodian will deduct fees from your investment portfolio, per your investment agreement documents, and forward these fees to the advisor as his/her/their compensation. This typically occurs quarterly, but can occur at other intervals. The custodian will generate your investment statements. Other advisors invest your money for you AND hold the money/investments in their own accounts, for your benefit. These arrangements provide an Increased chance of fraud. With this arrangement, the advisor will create your monthly, quarterly and annual investment statements based on their own accounting. With only 24 Hours in each day, and a compensation system based on the amount invested, it is easy to see how both models pay more for obtaining and servicing large investors. It is a simple reality that the small investor will not receive the same ongoing attention afforded the BIG money!