With Financial Advisers, Does Size Matter?


When it comes to the professionals who help manage your money, does size matter to you? More investors are going small. Here's what you need to know about both options.

As of late, independent financial advisers have been picking the pockets of national, full-service brokerage houses like Merrill Lynch (Stock Quote: MER) and Smith Barney. These registered investment advisers—known as RIAs—are grabbing the majority of new assets from the major brokerage complexes, according to an October 2008 report from Citigroup (Stock Quote: C).

How RIAs Compare to Brokers
RIAs are usually small, 10 employees or fewer, whereas full-service brokerages may be national or international in scope, with many branch offices. Because these large branches have long been linked by special communications systems, they are also known as “wirehouses.” Historically, wirehouse brokers have been paid primarily via a combination of fee-based and commission revenue:

  • They may be paid a fee assessed on their clients assets, regardless of what products are sold.
  • They may be paid a commission on how much insurance or what sort of funds they are able to market.
  • They may be compensated based on a combination of the two methods.

RIAs, on the other hand, are primarily fee-based, and unlike wirehouse brokers, they are fiduciaries with a stated responsibility to act in their client's best interest. Unless an RIA is dually licensed and affiliated with a broker-dealer, for instance, RIAs cannot sell products like insurance or mutual funds. Instead, they advise clients on investments, financial planning and money management, and may refer investors to product marketers as they see fit.

“Clients vote with their money and RIAs are winning by a landslide—Schwab, Fidelity and TD Ameritrade's (Stock Quote: AMTD) RIA segments have brought in more net new assets than Merrill Lynch, Smith Barney, Morgan Stanley (Stock Quote: MS), and UBS (Stock Quote: UBS) combined over the last six quarters,” states Citigroup's report, which surveyed RIAs late last June.

This is not necessarily a reflection on the quality or reputation of the Wall Street firms, but more a function of how the marketplace works.

Because the RIAs and wirehouses are targeting clients “in the same net-worth tier, as RIAs grow share it's often going to be at the expense of the wires,” according to Scott B. Smith, senior analyst with consulting firm Cerulli Associates in Boston.

Citi’s survey comes at a time when some investors are souring on the big names that once engendered so much of their trust, given the losses and failures that have plagued the biggest brokerage firms. More and more investors are asking, “If these companies can’t manage their own money, how can I trust them with mine?”

The Credibility Question
According to Cerulli, affiliating with a large national had previously given wirehouse advisers “credibility and stability.”

“These firms have strong reputations and enormous goodwill developed over the years,” states a recent Cerulli Associates report. On the other hand, it continues, “the headlines of 2008 have been riddled with questions about the ongoing stability or even existence of some of these firms thereby eliminating much of their branding advantage in the minds of knowledgeable consumers and advisers.”

At the same time independents are strengthening their infrastructure. “While the wires have built a strong support system over many years, RIA service agents such as Schwab, Fidelity and TD Ameritrade have been able to recreate many of the support structures formerly only offered through large broker-dealers,” says Smith. When advisers break away from the full-service firms and set out on their own, there are more options these days thanks to advances in technology systems and trading platforms.

Fees vs. Commissions

Another recent new study, this one conducted by Opinion Research Corporation on behalf of TD Ameritrade, found that most Americans—60% of those surveyed—would be most comfortable taking advice from someone being paid a flat fee ($5,000  to $10,000 for performing a detailed financial analysis, for instance), or based on a percentage of assets under management (1% of the customer’s portfolio, for instance)—instead of being paid a commission that depends on the amount of insurance or mutual fund shares a broker is able to sell.

On average, 90% of an RIA firm's revenue comes from fee-based sources, according to the Citi research. At most major Wall Street firms, there is probably a “50/50 split,” between fee-and-commission-based income, says Smith.

What’s The Best For You?

Some investors may prefer a firm with “16,000 employees versus 10,” says Smith, but RIAs say that they can be more objective than the competition because their revenues don’t depend on commissions, which may be pushed by the company, whether or not it is in the customer’s best interest.

“For retail investors, I think it still comes down to who do they trust,” says Smith, especially as broker-dealers are moving more toward fee-based accounts as a way to get a more constant, “repeatable,” revenue stream. Says Smith, “If they trust their adviser, it really doesn't matter what the sign on the door says.”

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