What Is an Investment Adviser?

September 21, 2022

The SEC (U.S. Securities and Exchange Commission) has a three-pronged definition of an investment advisor, as established in the U.S. Investment Advisers Act of 1940. To be an investment adviser, you must (1) be engaged in the business of (2) providing investment advice or issuing reports on securities, (3) for compensation.

An investment advisor with sufficient assets to be registered with the SEC is known as a Registered Investment Advisor (RIA). Investment advisory companies (IAC) are also registered entities.

Common names for investment advisors include asset managers, investment counselors, investment professionals, investment managers, portfolio managers and wealth managers. Individuals who work for and give advice on behalf of RIAs are called Investment adviser representatives (IAR).

How Investment Advisors Work

Investment advisors work as professionals within the financial industry by providing investment advice to clients in exchange for fees. Investment advisors owe a fiduciary duty to their clients, meaning they are required to put their clients’ interests first at all times.

Investment advisors must also be careful to avoid any actual or perceived conflicts of interest.

One way in which investment advisors seek to minimize real or perceived conflicts of interest is through their compensation structure. Investment advisors are paid through fees, which cause their success to be linked to the client.

For example, an investment advisor may charge a management fee based on the size or performance of the client’s assets. That way the advisor has a clear financial motive to work towards the client’s success.

Investment advisors often have a level of discretionary authority that allows them to act on behalf of their clients without having to obtain formal permission. However, this authority must be formally provided by the client, generally as a part of the typical client onboarding process.

What is Fiduciary Duty?

Advisors are bound to a fiduciary standard that can either be regulated by the SEC or state securities regulators, depending on the scale and scope of their business activities. The Act of 1940 is very specific in defining what a fiduciary means. 

One example of the duty of care for IAs is the specific trading practices that are illegal such as front-running and churning. Front-running means buying securities for their personal account prior to buying them for a client. Churning refers to making trades that may result in higher commissions, instead of prioritizing suitability for the client.

Additionally, the advisor needs to place trades under a “best execution” standard, meaning that they must strive to trade securities with the best combination of low-cost and efficient execution.

Regulation Best Interest (Reg BI) is an SEC rule requiring broker-dealers to only recommend financial products to their customers that are in their best interest. Broker-dealers must also clearly identify any potential conflicts of interest and financial incentives they might have for selling those products.

How Do Investment Advisors Make Money?

Using an investment adviser firm can be very beneficial but they come at a cost. There are two typical fee structures investment advisors use:

  • Fee-only: These advisors charge a flat or asset-based rate for their services. This is their only method of compensation
  • Fee-based: These advisors both charge clients standard fees and earn commissions from the sale of financial products. These products can include the sale of securities or insurance policies.

What Do Investment Advisors Provide?

Many investment advisors provide financial advice and guidance to individual investors. That advice can range from investment decisions to portfolio management or even just how to choose other advisors to work with.

While working directly with individual investors is the most recognized function of investment advisors, some prefer a more back-end role. They may manage the investments in client portfolios while leaving face-to-face financial planning to other advisors. 

Other advisors may choose to focus on financial analysis by researching and writing industry reports on investments or market trends.

Investment advisors can provide investment advisory services that include:

  • Determining your risk tolerance and financial situation in order to create a bespoke investment strategy personalized to the client’s investment objectives.
  • Portfolio management with either brokerage services or discretionary services — including asset allocation as well as the trading of individual stocks, bonds, mutual funds, or alternative assets.
  • Wealth management services such as trust and estate planning, retirement planning, or debt refinancing.
  • Assistance in understanding alternative investments such as real estate, contemporary art, or NFTs.
  • Tax planning and advice
  • Saving for important life events
  • Insurance coverage
  • Additional advisory services.

Who Must Register as an Investment Advisor?

Any financial professional who fits the definition of Investment Advisor as defined by the US Investment Advisers Act of 1940 must either register as an advisor or qualify for an exception.

This mandatory registration, and the regulation that follows, is what makes investment advisors unique. The SEC shares the duty of regulating these advisors with state regulators.

Investment advisors who hold $110 million in assets under management (AUM) are overseen by the SEC while advisors below that threshold are typically governed by the state. An investment advisor can voluntarily register with the SEC once they reach $100 million, but are required once their AUM exceeds $110 million.

The SEC and state securities regulators set requirements for investment advisors to hold them accountable. For example, all registered investment advisers must have a written policy on insider trading, privacy and a code of ethics.

Investment adviser firms regulated by the SEC must file required registration forms (“Form ADV”) to the SEC via the Investment Adviser Registration Depository (IARD). Firms register individuals by completing a form (U-4) through the electronic Central Registration Depository (CRD).

What Are Exemptions to Registration?

There are two commonly relied upon registration exemptions under the Advisers Act: the private fund adviser exemption and the venture capital fund adviser exemption.

  • The Private Fund Adviser Exemption: An advisor is exempt if it solely advises private funds and its total regulatory AUM in the US is less than $150 million. Private funds are pooled investment funds that must have either (1) fewer than 100 beneficial owners, all accredited investors, and not make any public offerings, or (2) all beneficial owners must be “qualified purchasers” and not make any public offerings.
  • The Venture Capital Fund Advisor Exemption: An advisor is exempt if the advisor solely advises venture capital funds as defined by the Investment Advisor Act of 1940.

Investment Advisor vs Financial Advisor

The terms investment advisor and financial advisor are often used interchangeably, but they are not the same. “Financial advisor” is a catch-all phrase referring to many kinds of financial professionals. “Investment advisor” is a legally regulated term for individuals or companies.

Since the term financial advisor casts a wide net, it can be confusing to know whether someone can legally provide investment advice.

Investment advisors do not have to take a specific qualifying exam, but they generally must pass certain licensing requirements set by FINRA (Financial Industry Regulatory Authority) in order to practice. Many advisors also have other certifications like Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA).

These designations may allow them to offer more holistic financial advice such as advice on how to budget, consult on taxes, retirement planning, paying down debt, or general wealth management, in addition to investment advice.

Do You Need an Investment Advisor?

Whether you need an investment advisor depends on your individual financial situation and knowledge of the markets. You should ask yourself how comfortable you are selecting, monitoring and managing your investments yourself.

Generally speaking, the more complex your financial situation the more likely you are to benefit from professional investment management. If your finances are more straightforward or you want an inexpensive alternative to an in-person advisor, there are various online advisory services, or even robo-advisors available to help build and manage your portfolio.

If you decide to look for an investment advisor, it is important to vet all professionals to ensure their certifications or licenses meet your needs. It can help to ask an advisor about their qualification, experience, and fee structure.

You also can look up an investment advisor’s background through the FINRA BrokerCheck, which offers information on both SEC- and state-registered investment advisers.

This material is provided for informational and educational purposes only. It is not intended to be investment advice and should not be relied on to form the basis of an investment decision.

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