Broker-Dealers vs. Investment Advisors (2024)

Broker-dealers and investment advisors can both play a crucial role in their clients’ financial lives by serving each one’s specific situation and needs.

Although the terms sound similar, these two financial professionals actually operate under different rules and for different reasons. Everyday investors should understand the difference betweenbroker-dealersand investment advisors, as well as several common terms connected to these roles, so they can decide with confidence how their portfolio is handled.

Standards for investment advisors vs. broker-dealers

Investment advisors, sometimes known as wealth managers, are a person or firm that is engaged in the business of providing advice, making recommendations, issuing reports, or furnishing analyses on securities for compensation.

The compensation is generally in the form of an advisory fee assessed as a percentage of the assets under management. For example, investment advisers work with clients to develop strategies and allocate investment portfolios to help clients pursue their goals. Investment advisors may be ideal for investors who want someone else to manage their investments, or for investors who want assistance with planning for taxes, an estate, or a mortgage.

In contrast, a broker-dealeris a person or firm that can buy and sell securities on its own account as well as on behalf of clients. Theycan recommend products that net them a commission, but an investor must approve each transaction. Technically, a broker is in the business of buying and selling securities on behalf of its clients, and a dealer buys and sells securities for its own account. A broker-dealer does both. Broker-dealers may appeal to investors who want to be more proactive in managing their own portfolios.

As a result of the different ways these professionals work, they abide by different legal standards. Investment advisors follow a “fiduciary standard,” while broker-dealers follow a “suitability standard” or “best interest standard.”Investment advisors, sometimes known as wealth managers, are a person or firm that is engaged in the business of providing advice, making recommendations, issuing reports, or furnishing analyses on securities for compensation.

The compensation is generally in the form of an advisory fee assessed as a percentage of the assets under management. For example, investment advisers work with clients to develop strategies and allocate investment portfolios to help clients pursue their goals. Investment advisors may be ideal for investors who want someone else to manage their investments, or for investors who want assistance with planning for taxes, an estate, or a mortgage.

In contrast, a broker-dealeris a person or firm that can buy and sell securities on its own account as well as on behalf of clients. Theycan recommend products that net them a commission, but an investor must approve each transaction. Technically, a broker is in the business of buying and selling securities on behalf of its clients, and a dealer buys and sells securities for its own account. A broker-dealer does both. Broker-dealers may appeal to investors who want to be more proactive in managing their own portfolios.

As a result of the different ways these professionals work, they abide by different legal standards. Investment advisors follow a “fiduciary standard,” while broker-dealers follow a “suitability standard” or “best interest standard.”

• Fiduciary standard.Investment advisors must put their clients’ interests above their own, give their client’s undivided loyalty, and may not engage in activity that conflicts with a client’s best interest without the client’s consent. The fiduciary standard is regulated by the Securities and Exchange Commission (SEC) or state securities regulators.
• Suitability/best interest.Broker-dealers aren’t required to put their clients’ interests before their own. The suitability standard does require that broker-dealer recommendations be “suitable” for their clients. For example, they must make sure their recommendations fit clients’ financial needs and goals and that the transaction costs are not excessive.

Other key terms

The following terms are used in these rules and may be important for investors to understand:

• Conflict of interest. When a financial professional may benefit from recommending a particular product or trade, that situation is considered a conflict of interest. While the phrase may seem to have a negative connotation, it’s not necessarily a bad thing when a financial professional has a conflict of interest, but it is something to be aware of so investors can form their own opinions about any recommendations.
• Recommendation. This is when a financial professional suggests a client buy, sell, or hold a security. Both investment advisors and broker-dealers can make recommendations, but recommending investments is a common job of broker-dealers. Some broker-dealers may offer blanket recommendations or the same recommendations to all their clients. Others may offer a recommendation specific to a portfolio. Broker-dealer representatives may be required to provide background information on themselves, such as accreditations and certifications, when making a recommendation.

Where these terms might apply

You may have seen these terms in financial news because the SEC continues to revise the code of conduct for broker-dealers through rules called Regulation Best Interest (Reg BI).

Since June 30, 2020, brokers are now required to comply with the requirements of Reg BI when making recommendations to retail customers, including requiring a broker-dealer to act in the best interest of the customer when making a recommendation of any securities transaction or investment strategy involving securities.However, broker-dealersare only subject to fiduciary duty at the specific point-in-time a recommendation is made, not the continuous and ongoing fiduciary duty that investment advisors are subject to.

In addition to adopting Reg BI, the SEC also clarified regulations on the conduct of investment advisors to “help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circ*mstances.” Essentially, the idea is to add protection for clients who are receiving recommendations.

Bottom line

With your own portfolio, you may find you’d prefer to work with a broker-dealer over an investment advisor, or vice versa.

No matter which type of professional has a role in your financial life, it’s good to be aware of how they work and the rules they must follow as they buy securities for you. That way, you can be aware of any potential risks that could end up costing you extra money.