Decrypting the Investment Industry Puzzle

By Scott McClatchey, CFP®

Confused by all the industry jargon many financial professionals like to use?  You’re not alone.  Equity, fiduciary, wirehouse, robo-advisors, fixed income, and ETF’s are but a few words which may be confusing if you’re not familiar with this industry.  In this article, I’ll hopefully give you a better sense what all these terms – and a few more – mean in simple, understandable language.  My intent is to de-mystify the investment industry and provide a sort of “decoder ring” for consumers to use.

If you’re searching for an investment professional to manage your portfolio or need a financial planner to help with retirement planning, the financial services industry offers two very different business approaches.  The “wirehouse” model consists of financial professionals who work for a large firm, typically with a national footprint, and receive support and benefits from that firm.  Many wirehouses are divisions of the banking conglomerates.   Sometimes these wirehouses will feature proprietary investment offerings along with cross-branded service offerings.

The other model consists of “independent” financial professionals working as independent contractors either in conjunction with a broker/dealer or a registered investment adviser (RIA).  Independent financial professionals generally own their own computers and office equipment, rent office space, pay their own phone and Internet bills, place their own ads or sponsorships, and purchase wholesale account services to conduct their business.  These “independents” are business owners just like locally owned restaurant owners, chiropractors, plumbers, or auto mechanics.

I am an independent advisor, for example, as are the other client-facing advisors at WWM Financial, which is set up as an RIA.  In 2007, I co-founded Alliance Investment Planning Group, located in Carbondale, IL, which is affiliated with the largest independent broker-dealer in the U.S.  These are two examples of the “independent” model.  A notable difference is in naming conventions: Wirehouses have branches of the parent firm located throughout the U.S., all carrying the name of their parent company.  Whereas independents generally create their own name – e.g., WWM Financial, Alliance Investment Planning Group, Jack & Jill’s Investment Group, Humpty Dumpty’s Planning LLC.

In terms of the financial professionals themselves, there are different types of professionals depending on which licenses have been obtained and services are being offered, along with the commensurate regulations that apply to each type.  For example, a registered representative, which is more commonly called a securities broker or stockbroker, has passed FINRA exams such as the Series 7 exam and is licensed to sell different securities and products such as stocks, bonds, options, and mutual funds.  Registered rep’s are regulated by FINRA, the self-regulatory organization (SRO) authorized and overseen by the Securities and Exchange Commission, or SEC, and are transactions-based providers held to a suitability standard which requires brokers to only recommend investment products suitable for a client’s circumstances.  Registered rep’s generally follow a more sales-oriented model, charging commissions for the purchase and sale of securities similar to those in a wirehouse.

The other primary type of financial professional is an investment adviser representative, more commonly referred to as a financial advisor or investment advisor.  Financial/investment advisors must pass the Series 65 exam (or a combination of the Series 7 and 66 or possess a professional designation such as the CFP® or ChFC®) and are regulated by their state or the SEC, depending on how many assets they manage.  Financial/investment advisors counsel clients on investing and financial issues and are held to a higher legal standard (e.g., than suitability) called a fiduciary standard or duty.  Most financial/investment advisors do not charge sales commissions for investment products, but rather an asset-based fee for their ongoing investment advice typically expressed as a percentage of the assets under management.  The fiduciary duty requires advisors to place their client’s interests above their own, and to eliminate conflicts of interest and properly disclose to their clients all those that are not.  Suitability is essentially a subset of the fiduciary duty.

Here’s the really tricky part.  Stockbrokers and investment advisors can be found in either wirehouses or broker-dealers or RIAs.  In fact, some financial professionals are dual-registered, meaning they can offer financial products on a transactional commission basis as a registered rep, but can also provide ongoing financial or investment advice on a fee basis.  So for example, a dual-registered broker/advisor affiliated with an independent broker/dealer could be managing a taxable account for a client set up as a commission-based brokerage account, meaning the broker is held to the suitability standard for this transactional account.  That same client may have another account with the same financial professional set up as a fee-based account, which would legally be held to the higher fiduciary standard.  Confused?  Yes, I understand, it isn’t as easy as it should be to figure out what type of professional you’re working with, how they’re compensated, and what legal standard they’re held to.  My advice?  Ask, and do your research before hiring someone.  The SEC provides a site for consumers to help with that research: www.adviserinfo.sec.gov.

To make matters even more confusing, there are many credentials available and in use inside the financial services industry by brokers and advisors, some very meaningful and others less so.  Perhaps the most respected and significant designations are the CERTIFIED FINANCIAL PLANNERTM, or CFP®, the Chartered Financial Consultant, or ChFC, and the Chartered Financial Analyst, or CFA.1  These designations all require college-level coursework, passage of examinations, extensive time commitments, and sometimes an experience and ethics criteria as well.  The CFP® and ChFC credentials require knowledge and testing on a broad array of financial topics, including taxes, insurance, investments, employee benefits, retirement planning, educational savings plans, and estate planning.  If you want to work with someone who has invested time and effort into their career and has a broad financial knowledge base, it might be worth considering a CFP® or ChFC professional.  CFA’s, on the other hand, are more specialized in investments and specifically investment analysis.  Many mutual fund or hedge fund managers are CFA’s, generally cutting their teeth as an investment analyst initially before eventually becoming the fund manager.  Which is better?  It depends on what you’re looking for.  If you only need help evaluating investment products, a CFA may be a reasonable choice.  But if you’re looking for a financial partner or consultant to help you navigate life’s myriad financial challenges, the CFP® or ChFC designations may be more useful in identifying prospective advisors for you to work with.

It’s important to realize that the credentials are distinct from the type of financial professional you’re dealing with.  A few registered rep’s, for example, have obtained a CFP® designation.  And many investment advisors do not have CFP®’s or ChFC’s or CFA’s.  But more commonly, CFP® and ChFC designations are associated with financial/investment advisors who do business as fee-based advisors/planners acting in a fiduciary capacity.  And CFA’s are more common in the fund management world (i.e., mutual fund, hedge fund, endowments) than in the client-facing world (i.e., stockbrokers, advisors).  This isn’t a hard and fast rule, but rather an observation on where the industry is today, and where it appears to be headed.  Each issuer of these designations provides an online search to determine if your advisor’s designation is in good standing.

To wrap this up, I wanted to quickly cover a few terms that sometimes confuse consumers unfamiliar with the financial services industry.  When brokers/advisors refer to “equities”, they’re generally talking about stocks.  Whereas when they refer to “fixed income”, they’re generally talking about bonds.  Which is unfortunate because bonds do not have fixed returns like bank CD’s, unless the bonds are held to maturity.  Investors who sell their bonds in the secondary market before maturity may get more, or less, than what the bond was originally sold for.  ETF’s are exchange-traded funds, a security similar to a mutual fund but actually traded on the stock exchanges.  Most ETF’s are index-trackers, but not all.  ADR’s are American Depository Receipts, which is how American investors can purchase foreign stocks listed on foreign exchanges, since each ADR represents a specific number of shares of a foreign-listed stock.  Finally, “robo-advisors” aren’t advisors at all, but rather automated investing services using computer algorithms to build and manage an investment portfolio.

I hope this short article helps decrypt some of the confusing language used by the investment industry.

1 “Four Best Financial Certifications” by Ellen Chang, U.S. News & World Report, August 11, 2020

 

Scott McClatchey is a wealth advisor and CERTIFIED FINANCIAL PLANNERTM with WWM Financial, an SEC registered Investment Adviser in Carlsbad, CA. He can be contacted by phone on 760-692-5190 or by email at  scott@wwmfinancial.com .

 

 

 

Disclaimer:

This commentary on this website reflects the personal opinions, viewpoints and analyses of the WWM Financial employees providing such comments, and should not be regarded as a description of advisory services provided by WWM Financial or performance returns of any WWM Financial Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. WWM Financial manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.