Q&A: Understanding Captive vs. Independent Advisors

·5 min read

Financial advisors have no shortage of career paths from which to choose. They may choose to be a representative at a major brokerage firm, such as Fidelity or Vanguard, or they could follow the franchise model with Edward Jones. Both are examples of being what's called a captive advisor.

Alternatively, advisors can be independent advisors, unaffiliated with any of the larger firms. The question for advisors is: Who do you want to be?

To help decipher the pros and cons of the various career paths available, we spoke with Ray Kathawa, vice president of practice development at M&O Marketing in Southfield, Michigan. As a consultant for independent financial professionals, Kathawa works with advisors who have been independent for decades and advisors who are just starting on their journey.

Kathawa shares the insights he's gained from more than a decade of experience in his role -- from how advisors can choose the right career path for themselves to how investors can determine which type of financial advisor they should partner with. Here are edited excerpts from that interview.

[SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]

Big firms like Vanguard and Fidelity have diverse offerings. How limited are captive advisors really? Do consumers need more options than such firms can provide?

It's true that captive advisors have a wide range of products available for use. If there are limitations, generally they come in the form of product-line restrictions. For example, insurance products, such as fixed indexed annuities, may not be approved for advisor use or approved in a limited capacity. So, in that example, the consumer may be limited in options.

How can consumers determine how limited or diverse an advisor's product offerings are before signing up?

The best way would be to ask the advisor and discuss it. Securities and Exchange Regulation Best Interest requires that an advisor make some disclosure about whether they only have a limited selection of products or a broad range of product solutions.

You want to know that your advisor has a range of solutions that is broad enough to effectively and competitively meet your needs. You want to avoid a narrow selection of solutions or a situation where only one or two product solutions always dominate.

[Read: Q&A With Ric Edelman on the Technology Sector]

What are the disadvantages or advantages to working with captive or independent advisors?

While captive advisors are limited in the solutions and products they offer to clients, independent advisors are not bound to a specific company and have many more products available to their clients. Conversely, independent advisors may not have access to certain proprietary products that captive advisors can offer clients.

Similarly, compliance tends to be more stringent in the captive world. The other side of that coin is that captive advisors tend to have more brand recognition that comes from national advertising campaigns done by the captive company.

What is the advantage of having access to proprietary products?

Proprietary products will have some competitive advantages because costs are saved somewhere in the client solution process. Advisors can be better trained. They can have higher business quality and higher compliance.

Proprietary products can be offered by agents and advisors who market a number of other products by the same financial company with a number of possible expense savings. With a competitive product, the higher sales of the product and an increase in sales of other products can justify the more competitive product.

Lastly, a good product can enhance the brand loyalty of both the financial professionals and their clients, increasing retention and marketing benefits.

How can advisors decide if they should go independent or be captive?

I would recommend talking with advisors from both the captive and independent side of the business to gain real insight into the advantages and disadvantages. If an advisor is just getting started in the business, they should also consider their budget and startup costs, as captive firms may be able to assist in that regard.

The independent advisor generally has to build a client base from scratch, so marketing and prospecting activity is required. Marketing costs money. You may be able to get away with working virtually initially, but at some point, you will want to hang your own shingle and open an office. Office space has a cost. You can probably operate solo at first without help, but as you grow, you will need employees. Employees are another expense. You need enough money to start and grow your business and live on until then. That number declines as your business grows, but a substantial initial investment is almost always needed.

Depending on growth goals and how aggressive you want to be on marketing, initial startup costs can be in the low six figures. I recommend talking to your local banks about small-business loans or lines of credit. It always helps to have capital in your corner.

[Read: Q&A: Improving Tax Efficiency in Investor Portfolios.]

How can and should advisors explain the difference between captive and independent to clients?

Transparency is very important in the financial services industry. Advisors should explain to their clients why they chose their particular business model, why they chose to work for one specific company or why they chose to be independent, and ultimately, why they believe their choice benefits the client. A great time for advisors to share their value proposition is when meeting a potential client for the first time. This is what I refer to as the "why me" phase of the relationship.

What should consumers look for when dealing with captive advisors?

Consumers should be aware that there may be other product solutions available that the captive advisor does not have access to. Additionally, some captive companies are offered financial incentives by product providers, which may influence the advisor's recommendation.

Clients want to know the solution they will be offered is a result of a professional process of reviewing and solving what they need. Clients don't want to just buy a product that may or may not work well. They want to know the financial purchase or investment they make is the best solution the professional can offer.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting