In last week’s article, we unpacked the role financial advisers play in the financial industry and got a better understanding of how they can help you make and implement workable strategies that will help you reach your long-term financial goals. In this week’s article, we will finish our discussion on financial advisers by taking a closer look at how their fee structures work and how it is disclosed. We will then shift to discuss the role brokers play in the financial industry which will give you a better understanding of how these various role players can help you on your financial journey.
Fee Structure
Financial advisers may be compensated through various methods, including fees, commissions, or a combination of both. Fee-based advisers typically charge a percentage of the client’s Assets Under Management (referred to as AUM) or in rare cases, an hourly rate for their services. This compensation structure aligns their interests with their clients’ financial growth, as their income is tied to the success of their recommendations. Some advisers do also charge performance fees so be sure that you understand how their fee structure works.
When you get a quote from a financial adviser, they will provide you with an Effective Annual Cost (EAC) which breaks down the annual cost of investing according to their recommended strategy. It is expressed as an annualised percentage and is made up of four components, which are added together. These components include the advice fee, which is paid to the financial adviser, the administration cost, which is paid to the product provider, the investment management fee which is paid to the fund manager investing and managing the funds and finally, ‘other’ fees which include performance fees. An EAC helps clients compare and understand the fees that will be levied on their investments to ensure they make an informed decision when accepting advice.
Fiduciary Duty
One of the most significant disparities between financial advisers and brokers lies in their fiduciary duty towards their clients. Financial advisers are held to a fiduciary standard, meaning they are legally obligated to act in their clients’ best interests. These standard demands that they put their clients’ welfare ahead of their own and disclose any potential conflicts of interest.
Broker
A broker, on the other hand, is a professional who acts as an intermediary between buyers and sellers in financial markets. They facilitate the buying and selling of financial securities, such as shares, bonds, unit trusts, and other investment products, on behalf of their clients.
Transaction-Focused
Unlike financial advisers who take a comprehensive view of a client’s financial situation, brokers are primarily transaction-focused. Their main role is to execute trades and carry out orders on behalf of their clients.
Commission-Based
Brokers earn their income through commissions on the transactions they execute. They receive compensation for each buy or sell order, which can sometimes lead to potential conflicts of interest if their incentives are not aligned with the client’s best interests.
Limited Scope
Brokers may offer investment recommendations, but their advice is generally limited to specific financial products. They do not engage in comprehensive financial planning or consider broader aspects of their clients’ financial lives.
Suitability Standard
Brokers are held to a suitability standard, which means they must ensure that the investments they recommend are suitable for their clients based on their financial situation, investment objectives, and risk tolerance. However, this standard falls short of the fiduciary duty upheld by financial advisers.
Both financial advisers and brokers play essential roles in the financial services industry, but their functions and responsibilities vary significantly. While financial advisers focus on comprehensive financial planning and act as fiduciaries, brokers primarily assist with investment transactions and adhere to a suitability standard. Choosing the right professional depends on individual financial goals, the level of guidance required, and the importance of a fiduciary relationship. Regardless of the choice, seeking professional financial guidance can help individuals make informed decisions and achieve their long-term financial objectives.
