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How Do Broker Dealers Make Money

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

Although many people are interested in the stock market, several common misconceptions exist. Inexperienced traders frequently confuse an investment advisor with a broker-dealer, which is one of the most widespread misunderstandings in the stock market.

The two terms may appear to be interchangeable, but in reality they each serve a unique purpose in regards to the particular investor.

When it comes to clients, financial advisors have a fiduciary duty, whereas stockbrokers only have an obligation to their employer.

But that’s not the only distinction. There are several distinctions between the two careers, including the regulatory frameworks, stock market standing, and financial services normally provided. The roles that investment advisors and broker-dealers play in the financial planning process will be explored.

What Is the Definition of a Registered Investment Advisor?

To maximize their clients’ financial success, the focus of a registered investment advisor (RIA) is on the stock market. Certified financial planners (CFPs) are wealth managers who care more about their clients’ total financial well-being than just their stock market activities. 

This distinguishes them from investment advisers, who focus solely on the stock market.
Financial experts are available to offer guidance on any decisions you may be considering regarding your investment portfolio.

Most financial advisers offer more than just advice; they also manage clients’ portfolios, relieving ordinary investors of the burden of day-to-day portfolio administration.

What Is a Broker-Dealer?

Investment advice is not something you can expect from a broker-dealer, sometimes known as a brokerage or broker. In fact, breaking the rules in this way is strictly forbidden. Instead, broker-dealers are like the used car shops of the stock market in that they hire brokers to do their bidding.

Their job is to make deals involving stocks and other financial instruments. Companies like Fidelity Investments, Charles Schwab, and TD Ameritrade are examples of reputable broker-dealers.

Broker-dealers have no vested interest in your investing success unless they also operate as investment advisors, as is the case with robo-advisor-broker-dealer firms like Betterment and Acorns.

The analogy with a pre-owned vehicle was chosen not without good cause. Unscrupulous broker-dealer practices contributed greatly to the escalation of the Great Depression in the years before the formation of the Financial Industry Regulatory Authority (FINRA). 

Broker-dealer fraud has been significantly reduced thanks to strict regulations, but remember that unless you’re dealing with a robo-advisor that also serves as a broker-dealer, your broker’s interest is likely to lie in making a profit rather than in your investment success. No matter what happens to the purchased stocks, a broker’s main objective is to make additional sales.

Broker-dealers provide a number of useful services to the financial sector, such as liquidity provision, trade facilitation, the dissemination of investment research, and the solicitation of money on behalf of businesses.

The Significant Differences Between Investment Advisors and Broker-Dealers

As can be seen from the above comparison, broker-dealers and investment advisors are two distinct business models. When determining which of these services is right for you, it’s crucial to think about the following:

How each acquires and disposes of stocks and other assets

You can trade stocks with a broker-dealer or an investment advisor. The primary distinction between stock and asset acquisitions and sales is the method of transaction.

Using an Investment Advisor to Buy and Sell Stock

Having a financial advisor on your side gives you an advantage when trading stocks. Your registered investment adviser has a legal responsibility to put your interests first when handling your investment portfolio.

Having a financial advisor on your side means that they will listen to your thoughts on stock trading and help you assess whether or not they are in your best interest.

In addition, it’s doable that absolutely no work is needed. An investment portfolio manager is like having a professional fighter on your side while working with a financial advisor.

Keep in mind, on the other hand, that the occupation of investment adviser is one of the highest paid in the United States. Experts in the field of investments will fight hard on your side, but they will expect payment for each blow they deal.

Buying and Selling Stock With a Broker-Dealer

You can participate in the stock market by buying and selling shares through a broker-dealer. However, the broker-dealer will not recommend specific stocks for purchase or sale. 

Providing guidance and managing investment portfolios both present significant potential for bias. The broker-dealer operates as a distributor for various financial goods and performs trades in securities on your behalf.

Remember that a fiduciary standard requires an investment adviser to put the client’s interests ahead of their own while working with a client. In the case of a broker-dealer, however, such is not the case. A broker-dealer generates revenue from its clients by charging commissions on stock purchases and sales.

Portfolio Management of Investments

Broker-dealers are completely unnecessary when it comes to managing an investing portfolio. They are unqualified to manage your portfolio since they do not care about meeting your investment return needs as a customer. In the case of robo-advisors, however, there are a few outliers.

Investment Portfolio Management Through the Use of an Investment Advisor

Portfolio management services provided by investment advisers go beyond simple financial advice. Instead, they will assume full control of your portfolio’s management.

When you hire an investing expert to manage your portfolio, they will make the purchases and sales that are necessary to help you reach your financial objectives. Actually, it is the fiduciary obligation of your investment advisor to do anything they can to assist you in achieving your financial goals through the use of any and all financial instruments accessible to them.

And it’s not only the right thing to do morally. Your adviser is required by law to offer investment recommendations that help you reach your financial goals under the Investment Advisers Act of 1940.

Portfolio Management Through a Broker-Dealer

When it comes to money, most broker-dealers only do one thing: operate as an intermediary between investors and the financial instruments they want to buy or sell, such as stocks, ETFs, mutual funds, and other investment vehicles, in exchange for a fee.

There are, however, a few cases that don’t fit the norm. Only robo-advisors that double as brokers/dealers are excluded from this rule. A good illustration of this is Betterment, a web-based service for managing one’s financial assets that doubles as both an investment advisor and a broker-dealer.

Betterment has set up a separate firm, Betterment Securities, to function as a third-party broker-dealer to prevent any potential conflicts of interest. Another similar robo-advisor is Acorns, which uses its own broker-dealer, Acorns Securities, to offer financial advice and handle client portfolios.

Investor Responsibilities

Due to their distinct roles in the stock market, investment advisers and broker-dealers owe their clientele distinct duties.

Investment Advisors Uphold Their Responsibilities

It is required of investment advisers that they provide excellent customer service. This concept of “fiduciary obligation” is bandied around frequently. Fiduciaries are investment advisors that are in good standing with the U.S. Securities and Exchange Commission (SEC).

They are legally bound to offer their customers sound investment management as fiduciaries. Financial planners can’t take commissions to recommend investments that aren’t in their customers’ best interest or to encourage the sale of securities.

Responsibilities Upheld by Broker-Dealers

It’s important to note that broker-dealers have unique legal obligations. Rather than looking out for the interests of individual shareholders, their primary duty is to ensure the safety of the stock market as a whole.

The Financial Industry Regulatory Authority (FINRA) mandates that broker-dealers provide their clients with only truthful and accurate information on the equities they provide.

It is the role of broker-dealers to facilitate the buying and selling of securities. Broker-dealers are ultimately liable for the successful transfer of shares or other securities and financial products.

Regulatory Oversight

It seems to be the reason that the operations of investment advisors and broker-dealers should be governed by separate bodies, given that they operate in polar opposite areas of the stock market.

Investment Advisor Regulatory Oversight

The Securities and Exchange Commission (SEC) is the government agency responsible for overseeing investment advisors in the United States. In the United States, an investment advisor falls within the authority of the Securities and Exchange Commission (SEC) once they have registered with the agency.

The SEC has the authority to punish investment advisors, prohibit them from providing services to the public in the future, and even press criminal charges against them if they are found to be behaving in a manner contrary to their customers’ best interests.

The SEC monitors investment advisors to make sure they adhere to the appropriateness standard, which mandates that clients’ individual circumstances be taken into account when determining whether or not an investment is right for them.

Regulatory Oversight of Broker-Dealers

Both the Securities and Exchange Commission and the Financial Industry Regulatory Authority are responsible for monitoring broker-dealers. The Financial Industry Regulatory Authority and the Securities Investor Protection Corporation are two examples of such organizations.

The SEC is a government agency, but FINRA and the SIPC are independent businesses. The Securities and Exchange Commission (SEC) created FINRA, a member-regulated agency, to relieve the SEC of some of its duties related to broker-dealers so that it could focus on suspected securities fraud by issuers and investment advisors.

As a result of the Securities Investor Protection Act of 1970, the SIPC was established. Most U.S. broker-dealers are regulated by this member-funded, non-profit institution, which is required by federal law. The SEC has jurisdiction over the SIPC as well.

The Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation (SIPC) are not federal authorities and so cannot bring charges against broker-dealers for misconduct in the provision of brokerage services. However, they have both advocated for the filing of charges against wrongdoers by the SEC, which has usually resulted in action. Prior to this happening, FINRA and the SIPC would issue fines and revoke registration for any broker-dealers found to be in violation.

Bottom Line

A broker-dealer or investment advisor is a professional who facilitates the buying and selling of securities. In spite of the fact that financial advisers do not come cheap, their advice might be the key to unlocking your portfolio’s full potential.

However, if you invest through a broker-dealer on your own, you have a better chance of outperforming the market as a whole.

It’s recommended to give yourself at least a day or two to think about the issue and assess the benefits and drawbacks of each possible course of action before committing to one. If you haven’t started investing yet, you should choose a strategy and get in as soon as possible to maximize the impact of compound interest.

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