Registered Investment Advisor (RIA) vs Broker: What’s the Difference?

Finding a suitable investment advisor can be tricky if you don’t know what you’re looking for. The world of asset management is vast and people often have different goals for their money. And of course, people have different opinions on what they’re willing to pay for an advisor to manage those goals. So where do you begin on your search for investment advice?

One of the biggest variations in the wealth management industry comes down to the broker-dealer vs Registered Investment Advisor (RIA) designations. These two broad categories encompass a majority of the firms and advisors you’ll find in the industry, but what is the difference between the two? The distinction comes down to this: a suitability vs a fiduciary standard.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

What are Broker-Dealers?

A broker is an investment professional who buys and sells on your behalf. Today, you can use several self-directed online brokers to manage investments on your own, but you still need that broker to gain access to the actual markets. The broker facilitates buying and selling on your behalf, usually for a commission—although many brokers have dropped commissions on self-directed stocks and exchange-traded funds (ETFs).

Brokers can also dabble in investment recommendations or open clients to new avenues like initial public offerings (IPOs) or hedge funds. When brokers operate multifaceted operations like this, they’re known as broker-dealers—they not only facilitate buying and selling, but they recommend and sell various investment products.

The primary compensation mechanism for broker-dealers is commission on the sophisticated products they sell, but this isn’t necessarily a system where expensive products are pushed at the expense of cheaper options. Broker-dealers are held to a “suitability standard” when making recommendations—the investment must be suitable, but it doesn’t have to be the best available choice for the client. Broker-dealers belong to the Financial Industry Regulatory Authority (FINRA), but aren’t individually registered with the Securities and Exchange Commission (SEC) like RIAs are.

However, this is still the free market, and in our opinion, broker-dealers who offer expensive, underperforming investments won’t hold on to their clients very long. Broker-dealers might not have the strict incentive restrictions that RIAs do, but they need to provide quality advice and investments that perform in order to stay in business. Broker-dealer commissions are often cheaper than the fee structure at an RIA, too.

What Are Registered Investment Advisors (RIAs)?

When it comes to investing and asset management, a Registered Investment Advisor is required by law to act in your best interests. That’s the standard set by the SEC, which must license all RIAs before they can operate in the United States.

The fiduciary standard is set by the Investment Advisers Act of 1940, which states that an investment advisor must act in the “utmost good faith” of their clients’ wishes. Unlike a broker-dealer, RIAs must disclose and/or eliminate any conflicts of interest that would impact their recommendations. If it comes down to a choice, the advisor must always select the option that most benefits the client, not the advisor or firm.

RIAs usually charge a percentage of assets under management as their fee, but some do also offer hourly rates. Total expenses at RIAs are usually a bit higher than broker-dealers since RIAs are typically geared toward high net worth clients who want specific experience and expertise from their advisor. RIAs also operate with more autonomy than broker-dealers, often making decisions without informing the client due to the fiduciary code.

Which Should You Choose For Your Investment Needs?

You can trust that an RIA will keep your best interests in mind when it comes to managing your portfolio. You have legal assurances that the advisor or firm won’t pad their own pockets with high-fee investments. And, since RIAs get paid a percentage of assets under management, the better your portfolio does, the more the advisor makes as well. It’s a symbiotic relationship highlighted by trust, and the investments are individually tailored to the client’s needs.

A broker-dealer doesn’t operate under a fiduciary standard and receives compensation through commissions, which does create the potential for perverse incentives. If two investment choices are equally suitable for a client but one will earn the advisor an extra 2% in commission, you can probably guess which one will be recommended. But broker-dealers aren’t pushy salespeople and most work hand-in-hand with clients to find the best investments. If you’re debating a choice between a broker or an RIA, consider your financial goals, risk tolerances, and how much you’re willing to spend for investment advice. Let those factors guide you when making a decision.

Work With an Experienced Financial Advisor

We hope you now understand the difference between a broker-dealer and a Registered Investment Advisor. If you have any questions or need help creating a personalized financial plan, don’t hesitate to reach out to a team member from Good Life Financial Advisors of Mount Pleasant today.