The stock market is a popular topic, but there are plenty of misunderstandings surrounding it. One of the most common stock market misconceptions among beginner investors is the idea that an investment advisor and a broker-dealer are the same thing. Although they might sound like they serve the same function, their relationship to the individual investor is different.
While investment advisors have a fiduciary responsibility to the investors they serve, stockbrokers — who work for broker-dealers — serve the broker-dealer they work for.
However, that’s not the only difference. The two professions are riddled with differences, including how they are regulated, their position in the stock market, and the financial services they typically offer. Let’s take a closer look at investment advisors and broker-dealers and how each of these financial professionals work with you.
What Is a Registered Investment Advisor?
A registered investment advisor (RIA) is a stock market expert whose goal is to improve the investing outcomes of their customers. Investment advisors should not be confused with certified financial planners (CFPs), which are wealth managers who are interested in the overall financial health of their customers, both from an investing standpoint and a personal finance standpoint, rather than simply their activities in the stock market.
As their name suggests, investment advisors are there to provide advice and support surrounding moves that you may be considering making with your investment portfolio.
Aside from simply providing advice, most investment advisors will offer portfolio management services, taking the control out of the hands of the retail investor and providing expert management of their investing assets.
Pro Tip: Have you considered hiring a financial advisor but don’t want to pay the high fees? Enter Vanguard Personal Advisor Services. When you sign up, you’ll work closely with an advisor to create a custom investment plan that can help you meet your financial goals. Learn More about Vanguard Personal Advisor Services.
What Is a Broker-Dealer?
A broker-dealer, often referred to as a brokerage or broker, is not there to provide investment advice. In fact, doing so would be going against regulations. Instead, broker-dealers are the companies that employ brokers and can be compared to the used car lots of the stock market. Their role is to wheel and deal in stocks and other tradable assets. Well-known broker-dealers include household names like Fidelity Investments, Charles Schwab, and TD Ameritrade.
Because the broker-dealer doesn’t provide advice to retail investors, they have no financial stake in your success as an investor, with the exception of robo-advisor-broker-dealer companies like Betterment and Acorns, which have separate divisions acting as the investment advisor and broker-dealer under one brand.
The used car comparison was made for a reason. Prior to the introduction of the Financial Industry Regulatory Authority (FINRA), unsavory moves made by broker-dealers played a major role in the development of the Great Depression. Although heavy regulation has cut down greatly on fraud among broker-dealers, it’s important to remember that unless you’re working with a robo-advisor that acts as its own broker-dealer, chances are that your broker’s interest is in generating a profit, rather than your investing success. A broker’s primary goal is to sell more stock, regardless of what happens to those investments after the sale.
Broker-dealers offer several services to the financial industry, including providing companies with liquidity, facilitating trading activities, publishing investment research, and raising capital for companies.
Key Differences Between Investment Advisors & Broker-Dealers
As you can tell from the brief descriptions above, investment advisors and broker-dealers are two completely different types of entities. Some of the most important aspects of these services to consider when deciding which is best for you include:
How Each Buys and Sells Stock and Other Assets
Both broker-dealers and investment advisors give you the ability to buy and sell stock. The key difference in terms of buying and selling stock and other assets is how those purchases and sales are made.
Buying and Selling Stock With an Investment Advisor
When you buy and sell stock with an investment advisor, you have an expert in your corner. Your registered investment advisor has a fiduciary responsibility to you, and that responsibility is to put your investment portfolio’s interest above their own.
So, when you buy and sell stock with an investment advisor, your advisor will listen to your thoughts and guide you through whether the moves you’re considering are in your best interest.
Moreover, you may not have to do anything. If you work with an investment advisor that provides investment portfolio management services, your pro isn’t just in your corner, they are in the ring fighting it out with the bulls and the bears on your behalf.
However, keep in mind that no expert service is free, and investment advisors are some of the highest paid professionals in the United States. So, although investment advisors will fight the good fight on your behalf, they’re also going to charge for every punch they throw.
Buying and Selling Stock With a Broker-Dealer
When working with a broker-dealer, you have the ability to buy and sell stock on the stock market. The difference is that the broker-dealer will not give any advice with regard to what stocks you should buy or sell. In fact, providing advice and managing investment portfolios would be major conflicts of interest. The broker-dealer executes the buying and selling of securities on your behalf and acts as a distributor for various financial products you might buy.
Keep in mind, when an investor works with an investment advisor, the investment advisor is bound by a fiduciary standard to act in the client’s best interest. That’s not the case with a broker-dealer. A broker-dealer makes its money by charging fees to buy or sell stock, profiting a little on every trade.
Investment Portfolio Management
When it comes to investment portfolio management, broker-dealers play no part. Because they are not interested in the client’s needs from an investment return standpoint, they wouldn’t be fit to manage your portfolio. However, there are some exceptions to the rule in the case of robo-advisors.
Investment Portfolio Management With an Investment Advisor
Investment advisors that offer portfolio management services don’t just offer up financial advice. Instead, they take the reins completely when it comes to activity in your investment portfolio.
When you allow an investment advisor to take control of your investment portfolio, your investment professional will take care of all buys and sells necessary to meet your financial goals. In fact, they’re not just interested in your success, doing everything they can to help you achieve your goals with all financial products available is your investment professional’s fiduciary duty.
It’s not just a moral duty either. Due to the Investment Advisers Act of 1940, it is your investment advisor’s legal responsibility to make investment decisions in line with your financial goals.
Investing Portfolio Management With a Broker-Dealer
Most broker-dealers don’t offer financial services of any sort outside of acting as the middleman for purchases and sales of investment products like stocks, exchange-traded funds (ETFs), mutual funds, and other financial products, earning a commission on each transaction made within brokerage accounts.
However, there are a few exceptions to the rule.
These exceptions are robo-advisors that operate both an investment advisory service and a broker-dealer. For example, Betterment is a wealth management platform that acts as an investment advisor and a broker-dealer at the same time. To avoid any conflicts of interest, Betterment has structured its company with a subsidiary that acts as a third-party broker-dealer, known as Betterment Securities.
Acorns is another robo-advisor that follows along the same lines, operating Acorns Securities as its third-party broker-dealer while providing investment advisory and portfolio management services.
Responsibilities to Investors
Because investment advisors and broker-dealers play different roles in the stock market, these financial professionals have a different set of responsibilities to investors.
Responsibilities Upheld by Investment Advisors
Investment advisors are expected to uphold a high level of client-facing responsibilities. Oftentimes, you’ll hear the term “fiduciary responsibility.” Investment advisors registered with the U.S. Securities and Exchange Commission, or SEC, are known as fiduciaries.
As fiduciaries, they have a legal responsibility to provide quality investment management for their clients. Investment advisors are not allowed to accept payments to promote or advertise for the sale of securities or make any investment decisions or follow any investment strategy that’s not in the best interest of their clients.
Responsibilities Upheld by Broker-Dealers
Broker-dealers are held to a different set of responsibilities. Their responsibilities are geared more towards the protection of the stock market as a whole, rather than the protection of a single investor or small group of investors.
Broker-dealers are required by FINRA to disseminate only true and accurate information about the stocks they offer to their customers.
Also, broker-dealers are in charge of facilitating securities transactions. Therefore, the successful transfer of shares or other securities and investment products is ultimately broker-dealers’ responsibility.
Because investment advisors and broker-dealers live on opposing corners of the stock market, it only makes sense that there are different regulators that oversee activities among the two.
Regulatory Oversight of Investment Advisors
Investment advisors are regulated by the SEC, an arm of the U.S. federal government. Once an investment advisor is registered with the SEC, they are under the purview of the regulator.
Should the SEC decide that an investment advisor is not acting in the best interest of its clients, the regulator can impose fines, bar the advisor from future service to consumers, and even file charges for breaches of U.S. securities law.
The SEC ensures that investment advisors follow the suitability standard, meaning that they only make investment decisions that are suitable for their customers.
Regulatory Oversight of Broker-Dealers
There are two major regulators that keep tabs on broker-dealers. These include FINRA and the Securities Investor Protection Corporation, or SIPC.
While the SEC is a federal regulator, FINRA and the SIPC are actually private companies. FINRA is a member-regulated agency that is overseen by the SEC and was designed to take some of the legwork with broker-dealers off the SEC’s hands, allowing the federal regulators to focus on potential securities fraud among issuers and investment advisors.
The SIPC was founded as a result of the Securities Investor Protection Act of 1970. It is a member-funded, nonprofit, federally mandated U.S. corporation that oversees most registered broker-dealers in the United States. The SIPC is also under the purview of the SEC.
Because FINRA and the SIPC are not federal regulators, they are unable to file charges against broker-dealers as a result of unsavory activities within their brokerage services. However, they have both been known to recommend that charges be filed by the SEC against wrongdoers, which generally results in action being taken. Before matters get to this point, FINRA and the SIPC will fine broker-dealers found in the wrong and revoke their registration, essentially closing them down.
The Verdict: Should You Choose an Investment Advisor or a Broker-Dealer?
The decision to choose to work with an investment advisor or a broker-dealer really depends on what you’re looking for from your financial professional. Are you interested in taking full control yourself, or would you rather have an investing expert in your corner?
You Should Contact a Registered Investment Advisor for Your Investment Activities If…
A registered investment advisor is a better fit if:
- You Have a Lot of Money to Invest. If you have a large portfolio with hundreds of thousands or millions of dollars of assets, it could be difficult for one person to manage. As a result, an investment advisor is going to be your best bet.
- You’re Not Familiar With the Stock Market. The stock market is a complex machine, and if you’re not familiar with what makes that machine run, it may be best to seek the help of an investment advisor.
- You Would Rather Let a Pro Take Control. If you’re not comfortable with risking your hard-earned dollars on your understanding of the stock market, it’s best to let a financial professional take the reins.
- You Don’t Have the Time to Devote to Research. To be a successful investor, it’s important that you perform due diligence, or detailed research, before making any investment decisions. If you don’t have the time for this research or the expertise to perform it, it may be best to seek the help of an investment advisor.
You Should Sign Up With a Stockbroker If…
A broker-dealer is a better fit if:
- You’re Confident in Your Investing Abilities. If you’re confident in your abilities in the stock market and have a strong investment strategy to follow, it’s likely best to avoid the additional fees charged by an investment advisor.
- You Have Plenty of Time to Devote to Research. As mentioned above, educated investment decisions come with research. If you have the time and inclination to research your investments, you can decide where to invest for yourself and rely on a broker-dealer to simply execute the trades that you choose on your own.
- You’d Rather Invest in Low-Cost ETFs. Low-cost ETFs are a great way to get around cumbersome research, as they provide a highly diversified way to expose your portfolio to entire indexes, sectors, and corners of the market. If you’d rather invest in low-cost ETFs than pay the high cost associated with an investment advisor, working with a broker-dealer is the best way to go.
- You’re Concerned With a High Expense Ratio. Investment advisors charge a percentage of your portfolio annually, on top of other potential fees. If you’re concerned about a high expense ratio in your investment portfolio, you’ll be better served by a broker-dealer.
Both Are Great If…
Both an investment advisor and a broker-dealer are excellent options if:
- You Need Help Along the Way. Nobody’s perfect, and it’s always nice to have an expert double check your work, regardless of what you’re doing. Many people work with broker-dealers to execute their own trades. Then, when they have a question about an investment, they’ll call an investment advisor and pay an hourly fee to discuss their investment portfolios.
- You Have Some Time to Devote to Research. If you are not going to let an investment advisor manage your portfolio, you’re going to need to devote some time to research. However, if you don’t have the time or expertise to do all of the research necessary, you’ll want to double-check your moves with an investment advisor before making them.
- You Have a Reasonable Understanding of the Stock Market. Finally, if you’re just getting your feet wet and are doing well with your investment strategy, but aren’t a pro just yet, continuing to trade with a broker-dealer on your own while hiring an investment advisor to oversee your stock market activity or manage a portion of your portfolio may be the best way to go.
Deciding to work with an investment advisor or invest on your own with a broker-dealer is not a decision that should be taken lightly. Although investment advisors come with a cost, their valuable insight may be what takes your investment portfolio to the next level.
On the other hand, it’s possible to outpace average market returns on your own by investing through a broker-dealer, but then again, that means that you’re on your own.
When making the decision, it’s best to take at least a day or two to weigh the pros and cons of each and make an educated decision as to which direction you’ll turn. Either way, if you’re not in the market yet, it’s important to pick one soon and start investing in order to take advantage of the power of compounding gains as early as possible.