The ABCs of Financial Advice

November 30, 2021

Like most industries, the wealth management field has its own “language,” with a range of terms, jargon, and acronyms used by people in the profession. If you’re investing, it’s wise to take the time to understand common terms – as well as their implications – to make sound financial decisions for your family.

To better understand the terms used today, it’s helpful to know how we got here. Decades ago, the role of the financial industry was largely centered around the delivery of financial products to the consumer. In this context, the role of the financial professional was that of an intermediary who was charged with delivering a product, rather than making a determination about whether or not that product would actually be helpful to the client.

These financial professionals were commonly called “brokers,” which makes sense, as they were essentially brokering the sale of a financial product to a consumer. For this service, a commission was charged for the sale and delivery of the product. The financial professional was incentivized to sell a product and was responsible only for describing the terms and features of the investment.

Over time, the financial industry has evolved from a commission-centric model to much more of an advice-centric model. This has been a great development for the consumer, as many financial professionals now operate with a greater standard of care and responsibility to the end consumer. Although more professionals operate under greater standards of care than in the past, there remain significant differences among advisors. For the consumer, understanding these differences is critical.

What is a fiduciary?

The term “fiduciary” can sometimes be confusing to people who are unfamiliar with the financial industry. In addition, the legal meaning of a fiduciary has changed over the years and has become more strictly regulated. Generally speaking, a fiduciary is a person or legal entity that has the power and responsibility of acting for another in situations requiring trust, good faith, and honesty.

In the context of providing financial advice, the fiduciary standard means that your advisor is required to act in your best interest – even if it is not in their interest – at all times. In addition, a fiduciary is legally accountable for the quality of advice delivered.

Compensation is a key factor to properly align incentives and to manage potential conflicts of interest. Regardless of the level of involvement you have with your investments, it’s smart to know your advisor’s fiduciary status and how he or she is compensated. This is a perfectly appropriate topic for discussion and is something your advisor should freely disclose and discuss.

Fee-based vs. Fee-only

We receive this question frequently, and many investors are not familiar with the distinction. Fee-based advisors can be compensated from client fees, commissions, and brokerage fees, which can create potential conflicts of interest. By contrast, fee-only advisors earn compensation from fees their clients pay, which is typically based on a percentage of assets under management (AUM). Because fee-only advisors do not receive commissions, it helps align their incentives with their clients.

Adviser vs. Advisor

One example of how difficult it can be to distinguish between financial jargon is the difference between adviser (with an “e”) and advisor (with an “o”). Although they might appear to mean the same thing, with a slightly different spelling, the differences, in fact, run much deeper.

An “adviser” is any person who advises, while a financial “advisor” refers to a licensed financial professional and is a formal job title within the financial services industry. Although the phrase “financial advisor” is commonly used, the Investment Advisers Act of 1940 actually uses the alternate spelling “adviser.”

Advisors have some degree of discretion in choosing the labels they use to promote their services. Ultimately, for the consumer, it’s helpful to know which label is simply a marketing choice, and which label comes with legally enforceable standards.

Investment professionals can use either term, but financial professionals who are "registered investment advisers" are legally regulated by the Investment Advisers Act of 1940, which was a direct response to the stock market crash of 1929 and the Great Depression. The intent of the law was to distinguish between salespeople who acted as brokers and financial professionals who offered ongoing investment advice to clients.

Open Architecture vs. Captive

An “open architecture” investment platform generally refers to an investment process which offers a wide array of investment choices. A “captive agent,” used in the insurance world, refers to an agent who is only able to sell products from a specific insurance company. Understanding which investment choices an advisor can choose from, and whether they have a financial incentive to choose one investment over another is another important distinction.

These are just a few of the terms and jargon within the financial services industry. As always, communication is key. Ask questions of your advisor and be sure you understand all the ways that your advisor may be compensated. A confident, well-informed investor collaborating with a qualified, experienced advisor can be a recipe for long-term financial success.

Please reach out to us for help navigating financial lingo and working towards your unique objectives.