Financial Advice Options for Young Professionals – Brokers
In the third of our four part series examining the various financial advice options for young professionals we look at the broker channel. Years ago, brokers were people that only the rich could afford. Individual investors had very little or no direct access to the market and had to place their orders through a licensed broker. Times have certainly changed as anyone can now have access to broker services, the trick is understanding what you are paying for and the type of information you are receiving.
The Difference between an Advisor and a Broker
Receiving advice and guidance through the broker dealer channel is much the same as it is for those receiving advice from an insurance agent, in that it can oftentimes be fairly product centric. Historically brokers, who oftentimes market themselves as advisors, have operated as the intermediaries between consumers and the purchase of various securities (i.e. stocks, bonds, mutual funds), much like a car salesman stands between consumers and cars.
A simple analogy helps to clarify the difference between advisor and broker. Imagine for a second you’re hosting a BBQ for a bunch of young family friends and need some good steaks for the group. What do you do? You likely go to the local butcher shop and ask the butcher for his best cut of steaks and he more than likely sells them to you. If you have your heart set on steak than this works great. Brokers operate as butchers helping consumers fill transactions and are rightfully paid to do so.
On the flip side, advisors are more like dieticians in that if you come to them looking to grill that weekend they are going to first take a blood sample, ask about your current allergies, medications, and family health history and only then make a recommendation on what you should grill that weekend. Instead of helping you purchase a product that is suitable for you, advisors help provide guidance in your best interest after fully assessing your needs and aspirations.
The Challenge for Young Professionals: Knowing Who’s an Advisor and Who’s a Broker
As John Oliver so entertainingly pointed out recently on his show, Last Week Tonight, the word advisor carries virtually no weight for the simple fact that anyone can use it. Unlike in the medical industry where only individuals who go through intensive steps to become a doctor can actually market themselves as a doctor, in the financial services world anyone can call themselves an advisor. A broker, insurance agent, financial planner, financial advisor, wealth advisor, financial consultant, the list of professionals that can market themselves as advisors is lengthy.
So how does a consumer know when they are working with a butcher or a dietician? In short, it’s really hard to know and therein lies the problem.
The big challenge for young professionals is knowing who to go to if all they want is steak (a.k.a. a stock, bond, or mutual fund) or if instead they have more comprehensive needs and are looking for more comprehensive guidance on their entire financial picture.
How Brokers Get Paid and Why You Should Care
In addition to the challenge of knowing who to turn to for your various financial needs as a young professional, it’s also important to understand how brokers get paid while assessing the various financial options you have.
Brokers are typically paid a commission for selling a product, oftentimes in form of an upfront load on a mutual fund or a commission on a stock or bond that is sold. For example, many young professionals looking for basic guidance in getting a portfolio set up might have $50,000 to invest. In this example, the young professional would pay an upfront load of 5% or $2,500 to get started and potentially an ongoing fee of 1.0%. This is increasingly expensive on a relative basis (if all you’re getting is help to simply place your investments) as technology has made it feasible to get the same thing for a fraction of the cost (see Betterment and Wealthfront charge 0.15 – 0.25%, eTrade and Scottrade charge $7.99, and Lifewise Invest charges 0.75%).
The second (and likely the biggest) issue that can arise when working with a broker is that the various products they have available to sell you may have widely different payouts to them, making it remarkably difficult for the broker to remain objective and with the client’s best interest at heart.
Take a simple example. Imagine you go to your broker looking for guidance on what to do with that $50,000. You and the broker settle on 70% stock and 30% bond allocation that is appropriate given your needs. The broker has a hundred mutual fund options available to help fill the two allocation slots (i.e. stock and bond) all with varying costs. Now imagine Fund A costs 0.15% and Fund B, which happens to be a proprietary fund managed by the broker’s firm, costs 0.95% and would help the broker hit his sales goals for the year and possibly qualify for a trip.
Which fund do you think the broker might recommend?
In closing, the takeaway is not that brokers are inherently bad, in fact far from it. I personally know many brokers that do great work for clients and are even better people. The takeaway, however, is that it’s important to be fully educated about the pros and cons associated with each of the various financial advice options young professionals have available to them, being especially aware of any potential conflicts of interest that may exist.
Take time to ask questions of the financial experts you are thinking about working with. Some good starting questions would be:
- What kinds of certifications do you hold?
- How are you compensated?
- How often do you plan on communicating with me?
- Will you put in writing that you will operate as a fiduciary with my interest ahead of your own, always?
Every individual’s situation is unique, make sure you select someone who can best meet your needs and help you met your financial goals.
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Providing the perfect blend of powerful technology and human guidance, Lifewise is geared toward young professionals searching for a better way to make wise choices and sound financial decisions. Backed by BerganKDV Wealth Management, Lifewise is supported by a team of CPAs, CFPs and CFAs who stand ready to guide you through every financial challenge and windfall.
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