At a recent dinner at a friend’s house, I was introduced to a business owner who had just sold his company for $7 million dollars. The newly wealthy gentleman, let’s call him ‘Dave,’ confessed that he had no idea how to get started investing his money. He wanted to know how advisors get paid, along with the differences between the firms and their relationships with their advisors. In other words Dave, like so many other neophyte investors, was in need of a primer on the wealth management industry, its peculiar lingo and how it works.

Our conversation went something like this:  

“For years I’ve seen these brokerage firms advertise, but I never paid much attention.”

“Which ads do you remember the best?”

“Well, there were the ‘When E.F. Hutton talks, people listen’ commercials, and the one where the bull walks through the jewelry store.”

“The bull in the jewelry store was Merrill Lynch. Hutton has been gone for 25 years, gobbled up by Shearson, which became Smith Barney, which was taken over by Morgan Stanley. Merrill was bought out by Bank of America but is still Merrill Lynch. Today there are four big national brands that the industry refers to as ‘wirehouses.’ They are Merrill Lynch, Wells Fargo, UBS and Morgan Stanley.”

“Why are they called ‘wirehouses’?”

“The term originated back when the headquarters of these large firms would communicate with their branch offices by wire.”

“Are the wirehouses still the biggest firms?”

“In terms of the number of advisors, they are still among the biggest. However, there are other big national brands, such as Ameriprise and Edward Jones, that are just as big but aren’t considered wirehouses.”

“Hmmm... So the industry needs new labels.”

“Agreed.”

“I see Fidelity advertise all the time. And Charles Schwab, too. Where do they fit in?”

“Both those firms make it easier for investors to manage their money themselves, either online or from one of their offices. But they also execute trades for a number of smaller brokerage firms and investment advisors. These smaller firms provide the same sort of advice and investment ideas, and access to the same products as the bigger firms, but they use Fidelity and Schwab to provide the trading technology, reporting and custodial services their  clients need.”

“So I could work with Schwab or Fidelity myself without an advisor? Or with a smaller firm that uses them for their services?”

“Yes, though both of them can also provide you with an advisor, if you deal with them directly.”

“This is kind of confusing.”

“Don’t worry, we’re just getting started. It’ll get more confusing as we go.”

At this point we decided to pause our conversation and return to the other dinner guests. But a few days later, Dave called me to take up where we’d left off.

 

DIGGING DEEPER 

“Okay, so I googled ‘wirehouse’ and learned a lot more. One of the things I saw was a fascinating debate about being a fiduciary or not being a fiduciary.”

“Ah, now you are digging deeper. This has to do with the differences between registered investment advisors, or RIAs, and brokers. A broker is supposed to give you recommendations that are ‘suitable’ for your needs based upon your age, your tolerance for risk and other factors, but does not have a fiduciary duty toward his or her clients. An RIA is a fiduciary and is obligated to put your interests ahead of his or her own interests.”

“Well, if that’s the case, nobody would choose to use a broker over an RIA!”

“On the surface that may seem true. But there are good and bad RIAs, just as there are good and bad brokers, and anybody you work with should explain any potential conflicts of interest. There are great advisors and crooks under both models, and in my experience, most of the best advisors who work under a brokerage model truly act as a fiduciaries and wish their industry would make it simpler for them to become fiduciaries.”

“So the broker gets paid on commission while the RIA gets paid on a fee basis?”

“Brokers can also get paid on a fee basis and are increasingly moving in that direction, but many clients still choose to pay commissions instead of fees. And many advisors are choosing to run their practices under a hybrid model, where they can act as both RIA and broker. But again, advisors with ethics and skills can work under either model.”

UNDERSTANDING 'BREAKAWAYS'

“Okay, let’s switch gears. I read about the ‘breakaway’ movement, and how some firms have breakaways but also employee advisors. Very confusing.”

“During the financial crisis, many of the big firms almost went out of business because they had so many bad mortgage investments on their books. Advisors at those firms, who were W2 employees, were forced to constantly defend their firms to their clients and to reassure them that their money was safe. Many of these advisors also lost a significant amount of personal wealth, because over the years they were forced to invest in their own companies’ stock. Once the crisis dissipated, more and more advisors decided to go independent and ‘break away’ from their old firms. These independent business models existed before, but the crisis induced more advisors to go this route to escape the problems of the big firms. In response, some of those firms offered their advisors a choice between continuing to work as employees or becoming independent contractors. The advisor can be an RIA or a broker or both. Raymond James, Ameriprise, Wells Fargo and HighTower all provide this type of flexibility to their advisors.”

“Whoa… You never mentioned Raymond James or HighTower before? How do they fit in?’

“Well, the label most used with Raymond James is ‘regional firm.’ At one point, that was an accurate description because the firm was based in Florida and its employee advisors operated only in the Southeast. But now it’s gone national with both its employees and its independent contractors. HighTower is a relatively new firm and hasn’t been pigeonholed like the others. It’s attracting breakaway advisors who want to be part of a fiduciary partnership, but is also setting up other advisors as independents and not part of its partnership.”

“Are there any other credible new firms?”

“Plenty—and more every month as a result of the breakaway movement, because top advisors usually have the same or better resources at their own boutique firms than they did at the big firms. And the big firms are still filled with quality advisors too. The more important challenge is finding an advisor who will fit your needs within one of these models. The point is that clients today are more loyal to their personal advisor than they are to the firm where their advisor works. And advisors have more interesting and credible choices than ever when it comes to the firm they work for or the business model they choose.”

FINDING A GOOD FIT

“Okay, I’m getting a much better sense of the industry now. So how do you suggest I actually find an advisor?”

“Did you like any of the people who called you already?”

“I liked one guy who was with one of the wirehouse firms.”

“So start there, and also ask friends for recommendations. Take your time. Remember, the individual advisor is much more important than the firm.”

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