If you’re looking for a financial advisor to work with, there are a number of important questions to ask. For example, it’s helpful to understand how advisors get paid and how they communicate with clients. However, consider asking if they work for a closed or open architecture firm. This can give you insights into the firm’s investment strategy. Here’s what it means and how it works.
Open Architecture Defined
Financial advisory firms can operate in one of two ways: using an open or closed architecture platform. A firm with a closed architecture platform only offers its proprietary products and services to its clients. An open architecture platform, has more investment offerings, including those from competitors.
In a closed architecture system, investors risk conflicts of interest within the firm. For example, firms may unfairly increase profit margins or put profits ahead of clients’ best interests.
Open architecture platforms, on the other hand, don’t limit investors solely to the bank or firm’s investment options. This means there’s less opportunity for conflicts of interest to happen or investor interests to be compromised.
Why Firms Use Open Architecture
It might seem counterintuitive for advisory firms to offer investments that aren’t their own. But there are some good reasons for advisors to go this route.
First, it allows advisors and financial advisory firms to take a more well-rounded approach to helping their clients. By looking beyond their firm’s investment choices, they can incorporate mutual funds or other investments into their clients’ financial plans. A closed architecture structure provides less room for customized investment plans based on the time frame, risk tolerance or goals.
By being better able to serve clients this way, open architecture firms may have better client retention rates. In other words, they’re less likely to see clients take their business elsewhere if they’re already offering the solutions they need in one place. Offering a broad range of investments allows clients to diversify and it also provides some insulation for the advisory firm as well since client returns aren’t based solely on the performance of its products.
Investors can benefit from open architecture if the advisory firm is choosing investments from outside sources that have the best return potential. When the advisory firm is a registered investment advisor, investors work with a fiduciary. They must act in the best interests of their clients. That goes beyond the suitability standard that broker-dealers must follow.
Open Architecture Downsides
While an open architecture system may be more appealing for investors who are looking for variety when building a portfolio, there are some potential drawbacks to keep in mind. Consider the cost, for example.
By limiting investors to choosing from proprietary funds or investments only, closed architecture firms are better able to keep costs down. An open architecture firm, on the other hand, may charge investors additional fees to take advantage of outside offerings. So there’s a trade-off you may have to consider when deciding what matters more: a wider selection of investments or keeping your costs as low as possible.
Regulatory rules for open architecture firms are also lacking, which presents a risk to investors in itself. That’s where it becomes important to ask the right questions when working with an advisory firm. For example, you should be aware of:
- Whether the firm is a fiduciary.
- How advisors are paid and what they charge.
- Whether they have a history of ethical or legal complaints.
A simple way to vet advisors and advisory firms is to use FINRA’s BrokerCheck tool. This free tool allows you to review employment history, certifications, licenses and complaints about investment advisors and brokers.
Should I Use an Open Architecture Firm?
The answer to this question is different for everyone. Deciding whether to go with a closed or open architecture firm depends on several things.
First, consider your investment goals for the short- and long-term. What do you need your portfolio to do? Are you looking to invest for growth, income or a mixture of both? When do you plan to retire and how much income would you like to be able to count on in retirement? The better you understand your goals the more clarity you can get on which type of platform to use.
Next, think about the cost and what you’re comfortable paying to invest. Keeping costs as low as possible in your portfolio means you get to hang on to more of your returns. But you have to balance the cost against performance when choosing investments. If an open architecture firm has a better return profile compared to one with a closed architecture structure, ask yourself what kind of trade-off you’d be willing to make where cost is concerned.
Finally, consider what kind of transparency a financial advisory firm offers with regard to investment selection, performance, pricing and account management. Whether you choose to go with open or closed architecture, it’s important to work with an advisory firm that doesn’t put unnecessary obstacles in the way of getting the information you need to make appropriate investment decisions.
The Bottom Line
An open architecture advisory firm operates with a wide horizon in mind when it comes to managing client assets. This might work if you want an advisor who takes a holistic approach to wealth management. Consider asking questions about the type and quality of advice you’re getting for your money.
- Consider talking to your financial advisor about what it means to use a closed or open architecture platform. They can tell you how that might affect investment returns and costs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When talking fees with financial advisors, ask whether they take fee-based or fee-only approach. A fee-based financial advisor can charge you fees but also receive commissions on the investment products they sell. Fee-only advisors only charge fees for the advice they give. These advisors have a fiduciary responsibility to recommend investment products that align with your best interests
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