Most of us will turn to financial advisors, brokers or investment funds at some point in our life – mostly during periods when we are saving money for long term goals like retirement. But how do you know which ones are good and which ones aren’t? How do you find out if they have any complaints against them?
The whole process can be daunting, especially if this is your first time dipping your toes into the water as an investor.
There are a few key things you can do to help make the process easier, and to protect yourself from any potential scams or bad actors. But first, let’s discuss the difference between a financial advisor and a broker.
Financial Advisor vs. Broker: What’s the difference?
A financial advisor is a person who, in the absence of any legal obligation, offers qualified advice to help you achieve your financial goals. A broker works on behalf of a brokerage firm that charges commissions for their services.
So what’s the problem? Brokers have a vested interest in recommending investments which pay them the highest commission from among those suitable for your investment goals. Advisors, on the other hand, are not beholden to any particular company or product and can recommend a range of investments which may be more appropriate for your needs.
That’s not to say that all brokers are bad – just that you need to be careful and do your research before entrusting them with your money.
The Different Types of Accounts a Broker May Open in Your Name
When you visit a broker or advisor for the first time, they may ask to set up an account in your name.
There are six common types of accounts they may open in order to manage your money:
1) Trading Account – This is the brokerage account where all buying and selling of assets is done. It is the account you interact with first and foremost as a retail investor.
2) Taxable Brokerage Account – This is an account which will collect any income, dividends or capital gains on the investments held within it until such time as those earnings are withdrawn from the account (at which time they become taxable). These accounts typically require you to sign a form called an 83(b) election.
3) Retirement Account – This is an account which allows you to save money on a tax-deferred basis so that you can use it later in life to supplement your retirement income. The two most common types are the 401k and the IRA.
4) Custodial Account – This is an account that holds money for someone else, usually a minor. It can also be used to hold securities belonging to retirees who are no longer able to manage their own affairs.
5) Educational Savings Account – This account allows parents or other relatives to set aside money on behalf of a child so they can use it later for their education. It can be set up as a 529 plan or an ESA.
6) Health Savings Account – This is the account you use to save money on a tax-advantaged basis for medical expenses and health care costs which aren’t covered by insurance (such as dental and vision care).
The Difference Between a Non-Discretionary and Discretionary Investment Account
When you set up an account with a financial advisor or broker, they will typically fall into one of two categories: non-discretionary or discretionary.
A non-discretionary investment account is one where the advisor must adhere to the client’s pre-determined investment plan. If the client wants to change their mind about any particular investment, the broker must get permission from them before buying or selling anything.
A discretionary investment account is one where the advisor has leeway to make changes without consulting their client first. They might suggest investments they think you should buy or sell, and if you disagree, they often do not have to obtain your consent before acting.
Why Does This Matter?
The type of account you have with a broker or advisor is important because it determines the level of control you have over your money. With a non-discretionary account, you are in charge – the advisor must follow your instructions to the letter. With a discretionary account, the advisor has more say in how your money is invested and may not be as interested in preserving your capital. Here’s a helpful guide I found that explains the difference between non-discretionary and discretionary accounts.
Research Your Advisor or Broker Before Signing Anything
If you’re thinking about working with a broker or advisor, the first thing you must do is research them. You should check them out thoroughly in order to make sure they are qualified to manage your money and that you can trust them.
You can search online for reviews written by other clients who have done business with the person before (although keep in mind that some people might be motivated to write negative reviews).
You can also check with the Better Business Bureau (BBB) or your state’s securities regulator to see if any complaints have been filed against them. In addition, you can check your Broker’s history by using BrokerCheck by FINRA. You can use this tool to look up both your advisor/broker or the brokerage firm you are thinking about working with.
If you’re still not sure, you can always ask the advisor or broker for references from previous clients.
Find a Broker/Advisor that is Patient with Your Questions
When you decide to work with a financial advisor or broker, it’s important that they are patient and willing to take the time to explain everything you need to know.
For example, when you’re looking at mutual funds, make sure they don’t rush you into selling anything off the bat. Many brokers are paid through commissions, which can give them an incentive to make you sell your investments at the wrong time.
Look for advisors who will need more than 5-10 minutes with you (if they say they do, ask them how it’s possible for you to know if you like them after only 5-10 minutes). They should be willing to take the time to answer all of your questions and help you understand everything you’re buying.
If your advisor or broker can’t or won’t do this, it might be time to look for someone else.
Related Read: Choosing The Right Kind of Broker
In Conclusion
Working with a financial advisor or broker can be a great way to invest your money and grow your wealth over time. However, it’s important to do your research before signing any contracts and make sure you find someone who is patient and willing to answer all of your questions.
When choosing an advisor or broker, it is important to know the difference between a discretionary and non-discretionary account. With a discretionary account, the advisor has more say in how your money is invested and may not be as interested in preserving your capital. Make sure to do your research before signing any contracts and look for advisors who will need more than 5-10 minutes with you. They should be willing to take the time to answer all of your questions and help you understand everything you’re buying.
If your advisor or broker can’t or won’t do this, it might be time to look for someone else.
