Important Distinctions Between ‘Registered Investment Advisors’ and ‘Financial Advisors’

July 22, 2024

Learn Which Financial Professional May Best Suit Your Needs

When it comes to managing your finances and planning for the future, seeking professional advice is a prudent step. Of course, there are various types of financial professionals, and it can be confusing to determine which you need. Two common roles you might encounter are Registered Investment Advisors (RIAs) and financial advisors. While both play crucial roles in assisting individuals and families with their financial goals, it’s essential to understand that they are distinct in their focus, services, and responsibilities. Below, we’ll dig into the RIA or financial advisor discussion to explain the differences and help you make an informed decision about which type of professional you can benefit the most from in your financial journey.

RIA or Financial Advisor? Understanding and Defining the Roles

If you’re trying to determine whether you need an RIA or financial advisor, the first step is to understand what each of these professional roles offers:

Registered Investment Advisor (RIA)

A Registered Investment Advisor (RIA) is a financial professional or firm registered with the Securities and Exchange Commission (SEC) or state securities authorities – like we are here at Davidson Capital Management. RIAs provide investment advice, retirement planning, tax planning, estate planning, and discretionary portfolio management services to clients. They are legally bound to act in their client’s best interests because they have a fiduciary duty to do so. The fiduciary “trust” standard is the highest known law in the financial services industry. You might think that anyone actively managing money for someone else would be required to meet this high level of client care, but that’s not the case.

Financial Advisor

A financial advisor is a broader term encompassing a wide array of professionals who help clients manage various aspects of their financial lives. This can include investment planning, retirement planning, insurance planning, tax planning, estate planning, risk management, and more. Financial advisors can create comprehensive strategies and sell financial products to achieve financial goals to address a wide range of financial needs. There are various certifications they can achieve, but the vast majority of financial advisors are not held to a fiduciary duty, so they are not legally bound to act in their client’s best interests. A financial advisor can be held harmless by providing “suitable advice” to their clients even if they know that the advice is not the best advice for their clients.

RIA or Financial Advisor? Key Differences

When you’re trying to determine which financial professional might be best for you, there are three important differences to consider:

1. Scope of Services

RIA: As mentioned already, an RIA firm primarily focuses on managing investments and portfolios. Their expertise lies in asset allocation, investment selection, security analytics, financial market analysis, economic analysis, security trading, and actively managing client assets in real-time market conditions. (All services our clients receive at Davidson Capital Management.)

Financial Advisor: These professionals provide comprehensive financial advice covering investments, retirement planning, tax strategies, insurance, estate planning, and more. They consider a broad view of a client’s financial situation, rather than focusing specifically on actively managing their clients’ investment portfolios. A lot of financial advisors provide financial plans that outline a client’s goals and aspirations, but a financial plan is not worth the paper it’s written on without the successful management of the client’s investment portfolio. Financial advisors are best suited to work with investors who prefer to make buy and sell decisions of securities in their portfolio.

2. Specialization

RIA: Again, one of the main differences to note in the RIA or financial advisor discussion is that an RIA specializes in active investment management as a fiduciary. This means they aim to optimize returns while managing risk according to the client’s risk tolerance, risk capacity, and financial objectives.

Financial Advisors: Specializes in creating and implementing personalized financial plans based on the client’s financial goals and circumstances, but most are not acting in a fiduciary capacity as an active portfolio manager. Financial advisors are primarily focused on financial product sells.

3. Regulatory Oversight

RIA: Registered Investment Advisors are governed by the Investment Advisers Act of 1940 and subject to “trust” regulations imposed by the Securities and Exchange Commission (SEC) or state securities authorities.

Financial Advisor: These professionals operate under the Securities and Exchange Act of 1934 regulatory frameworks which are less strict regulations concerning the “suitability” standard.

Intentional Decision-Making: Choosing the Right Financial Professional for You

There’s no “right or wrong” choice when it comes to the RIA or financial advisor decision. It comes down to what’s right for your personal circumstances. So, when determining which professional to work with, it’s essential to consider your financial needs and goals.

If your primary concern is discretionary active investment management and portfolio growth – and you want an expert who must always act with your best interests in mind – then an RIA could be the right fit for you.

However, if you need assistance with broader financial planning aspects, including tax, estate, and retirement planning, and you’re not overly concerned with a focus on optimizing your investment portfolio, then working with a Financial Advisor might be more suitable. If you’re the type of investor who prefers to make investment management decisions with your portfolio, a financial advisor is a better fit since they typically don’t have discretionary investment management authority.

It’s worth noting that, for most people, the best approach involves a combination of both. At Davidson Capital Management, we can help you create a comprehensive financial plan and can actively manage your investments on a discretionary basis in alignment with that plan.

A Final Note on Financial Advisors

Not to confuse the issue here, but any RIA or financial advisor discussion also bears mentioning that a stockbroker is yet another type of financial professional that is distinct from RIAs. A stockbroker’s primary service is to execute trades on behalf of clients, working to achieve the best possible earnings. There is often more risk involved when you’re using a stockbroker because they may be trying to time the market (which is very difficult for any professional to do, regardless of what they may tell you) and that means they may not have a strong, long-term investment strategy in place for you.

Stockbrokers are generally not under a fiduciary duty to make trades in your best interest. They may only need to meet a “suitability standard” instead, which offers you less protection and peace of mind. In fact, the suitability standard does not require a stockbroker to put a client’s interests above their own.

Stockbrokers might also call themselves things like “account executives” or “wealth managers” so be sure you know whether any financial professional you’re working with has a fiduciary duty to act in your best interests – or not. The best thing any investor can do is simply ask the investment professional you’re working with or thinking about working with if they are a fiduciary.

The Growing Trend of Financial Advisors Becoming RIAs

Over the last 10 years, we have identified a growing trend that has us at Davidson Capital Management concerned. This trend is financial advisors opening their own RIA firm to appear as a fiduciary advisor to prospective clients, only to continue to focus on selling financial products. What makes matters worse is that we have identified so many examples of former financial advisors turned RIAs portraying themselves to be experienced portfolio managers, which is extremely dangerous to all investors. We feel this trend has been growing over the years because investors have become more aware of the huge differences between a fiduciary advisor and non-fiduciary advisor. Smarter investors have caused the non-fiduciary advisors’ business to suffer. As the old saying goes, if you can’t beat them, join them.

The way most of the financial advisors turned RIAs get around their lack of portfolio management experience is outsourcing their clients’ asset management to a sub-advisory firm. For RIAs who utilize these services, it’s important that investors understand that their annual management fees will be increased due to the additional cost of the sub-advisory firm. We believe the fastest way to add more money to your portfolio’s bottom line is by keeping your annual asset management fees to a minimum. Another issue with the sub-advisory business model is the client will not have a direct personal relationship with the asset management team. We feel a direct personal relationship with an asset management team is critical to ensure an investor’s goals, risk tolerance, risk capacity, and financial objectives are understood and met.

Below are some important questions to ask an RIA you may be considering working with or to ask the RIA you may currently be working with:

Do you actively manage client assets in-house?
Do you use any sub-advisors to manage client assets?
If the RIA uses sub-advisors: What are the sub-advisor’s annual management fees?
If the RIA manages client assets in-house: Please describe your investment management philosophy.
Can you provide an investment performance track record based on your discretionary asset management decisions?
Do you sell investment products? If yes, please describe.
Do you sell insurance products? If yes, please describe. (If the advisor sells annuities, you need to run away as fast as you can!)

All advisors holding themselves out as an RIA must provide a prospective client with their firm’s ADV Part II. The ADV Part II is the roadmap as to how the RIA works with their clients. This document must be read and understood prior to working with any RIA.

Concluding Thoughts: RIA vs. Financial Planner

While there are many types of financial professionals that could play a role in helping you build a financial plan, there are major differences in how they serve you, the standards they must meet, and ultimately how comfortable you are reaching your financial goals may be because of their choices on your behalf. It is critical to choose a professional who understands your goals and who is bound by law to help you achieve them, ahead of their own personal success.

If you’re making the RIA or financial advisor decision right now, or you’re considering using a stockbroker, wealth manager, or other type of professional and you have questions, we’re happy to help. At Davison Capital Management, we’ve been providing RIA services in central and south Texas for more than 30 years. We help our clients invest with confidence, we meet the highest fiduciary standard, and our depth and breadth of experience along with our 30 plus years of a proven investment performance track record means we can help our clients achieve their investment goals. If you have questions or you’d like to learn more, please reach out to schedule a complimentary portfolio review with us today.