Learning the difference between a Wealth Advisor, a Portfolio Manager and a Trader

Nov 28

Learning the difference between a Wealth Advisor, a Portfolio Manager and a Trader

Like any natural habitat, the Wall Street ecosystem is populated with a wide array of forces interacting and competing with one another to ensure the greatest sustained benefit to themselves. This financial food chain includes everybody from the largest institutions down to the smallest retail traders and everybody in between.

Things can get confusing, however, because there’s a good chance that the average investor comes into contact with multiple areas of this ecosystem depending on their age, net worth, and other factors.

In the interest of clarity, we’ve put together a handy field guide to the three primary players that make up the bulk of financial services industry: wealth advisors, portfolio managers, and traders.

The Mighty Wealth Advisor

As the name implies, wealth advisors act as an advisory resource to individuals, estates, and businesses on how to best allocate their financial assets to meet their personal needs or goals. Most wealth advisors have a background in business administration or advisement.

There are a plethora of different accreditations that are associated with the designation, including CFPs, CIMAs, who advise individuals, to CPWAs, who cater to high net worth clients, and CTFAs, who minister to trusts. Because of the clients they cater to, these specimens often have tens of millions of dollars in assets under management (AUM), if not hundreds.

In their capacity as financial counsel, wealth advisors might recommend what mutual fund products or other assets to invest in, or which account types to use in order to optimize income for the coming tax year, or even coordinate any legal processes that their client might want or require to safeguard their holdings. Essentially, wealth advisors use their knowledge, experience, and personal insight to craft a comprehensive wealth management strategy tailored to each client.

As you may have guessed, wealth advisors can exercise a great deal of influence in the financial lives of those they serve, and that means their clients generally have a great deal of faith in the guidance their advisor provides. However, faith alone isn’t enough in this relationship, as wealth advisors are not infallible and, depending on what (if any) certification they have, they may not be required to work in their clients best interest.

Deciding on whether your finances are suited to the assistance of wealth advisor ultimately comes down to the scope of your financial needs and the track record of the advisors in your area. For the average investor, having a full-time, dedicated advisor could be helpful, but it might not be necessary. This is especially true if you just need occasional, informed assistance from a fiduciary or broker in managing investment accounts, in addition to the help of a family lawyer in filing a will or other executory legal documents. On the other hand, someone with a personal fortune, large estate, or other complex set of assets might well benefit from a trusted advisor in steering their finances exactly where they need to be.

As for ensuring that the advice you receive from an advisor is proffered in good faith, nothing beats doing your own research before making any decisions. Some, but not all, financial bona-fides carry the weight of ethics enforcement. Luckily, you can look up whether your wealth advisor is suitably credentialed using either the Security Exchange Commission’s (SEC) Investment Adviser Public Disclosure website, or, if they have less than $110 million AUM, on the state-level Financial Industry Regulatory Authority’s (FINRA) BrokerCheck network.

The Great Portfolio Manager

Unlike advisors, portfolio managers’ approach to the market is less focused on specific client needs and more concerned with delivering on their stated objectives. For this reason, individual managers are usually certified financial analysts (CFA) whose backgrounds are entirely economic and market-centric, which allows them to better undertake more complex market investment and trading strategies like arbitrage, capitalizing on cross-market inefficiencies and price discrepancies

Portfolio management’s performance objectives typically focus on how much return they intend to realize compared to a particular benchmark like the S&P 500 index, but also commonly include when and how they rebalance their portfolios as well as their strategy in mitigating the risk of loss. It’s for this reason that many portfolio management firms charge based on performance metrics, commonly charging a percentage of their total AUM, anywhere from 0.1-2 percent based on the type of asset classes being handled and the size of your own investment portfolio.

While that may sound like a fair arrangement, since the managers only make more when their client portfolio grows, there are a lot of factors that could impact the value of that fee. Not the least of these factors is the level of involvement the portfolio managers actually have in generating returns above what you might be able to get by investing in a simple index fund.

This means that the onus of finding and researching a suitable investment is even more upon you, the client, than with an advisor who might work through the process with you. Not only should you perform extensive research on individual manager’s actual performance — rather than backtested or retroactive models on how their current strategy might have performed in the past, a common sleight of hand in money management —but also how that relates to their fee structure as well as those of other firms.

Clients also need to research just what strategies any given portfolio manager uses in delivering their promised returns. Do you want your investments to potentially outperform the market? Then you might want to go with a manager that takes an active hand in managing your portfolio to take advantage of current market conditions and trends. Do you want your investments handled according to quantifiable changes in a market index? Then you should probably consider a manager that uses rules-based criteria to alter your investment exposure. Each portfolio manager will have their own approach toward allocating assets and selecting investment products, which makes the potential management options practically limitless.

Overall, you should approach portfolio managers with similar credulity you would give a wealth advisor. Your investment assets are just a small part of a management firm’s total holdings, so it’s up to you to ensure your savings don’t get lost in the crowd.

The Mad Trader

Finally, we have the most self-directed of the three financial market participants: traders. Basically, traders make their own investment decisions when and how they like, with some making trading their entire occupation. This means that the day-to-day activities of a trader are extremely short-term, with some trades lasting no more than a matter of minutes, since many traders are looking for immediate income over long-term savings.

Of course, there is usually a lot more than whimsy driving their trading decisions. There’s an apocryphal piece of market wisdom that says 90 percent of those who attempt to trade stocks end up losing money before quitting entirely. That’s because successful trading requires hard work, discipline, extensive research, and a substantial financial investment. Even then, success is never guaranteed. Whether a trader uses a strict set of rules, relies on fundamental information about a financial asset, uses technical equations and patterns or any combination of strategies, there is no certainty about what the next trading day will bring.

That said, there are two main subspecies within the trader designation that you should be aware of: retail traders and proprietary traders.

Retail traders are solitary creatures who perform trades through a broker-dealer like Fidelity, TD Ameritrade or Wells Fargo using their own money and accounts. This is likely the type most might imagine when they hear the word trader, a lone individual sitting at a computer console with eight different screens full of charts and spreadsheets, seeking out trading opportunities during stock market hours.

A prime reason behind why there is such a high turnover rate among retail traders is that it is extremely capital intensive. This is due to the fact that individual traders need to exercise an outsized amount of leverage in order to compete with the hundreds of billions of dollars being bandied about by large hedge funds, automated high-frequency investors, or any of the market contenders mentioned above. Retail traders also need to cover both the added costs of executing trades through a broker-dealer and accessing whatever research or stock tools they might pay for.

It’s for this reason that proprietary traders exist. Unlike retail traders, proprietary traders (or prop traders) work together by pooling their money and forming a business (commonly called a prop shop) whose sole function is to purchase financial assets wholesale — that is, not through a broker-dealer — and resell them on the market for a profit. Because all of the capital is pooled, proprietary traders have far more leverage over their retail counterparts. And, since they don’t have to pay fees to brokerages, prop traders realize 100 percent of their investment returns, although it’s usually split into some kind of revenue structure that reflects individual performance.

Like portfolio managers, prop traders usually have a formal training or special insight into the markets, hence the reason why they’re brought into the prop shop in the first place. This makes prop trading more of a typical “career” than retail trading, and prop traders ultimately have to answer for their performance. However, traders in general still have the benefit of undertaking riskier positions that may yield better short-term returns since they don’t have another person’s livelihood on the line.

Conclusion

Hopefully this brief ecological survey can help you identify what type of financial professionals you may need. Whether it’s in the steady hands of someone intent on building your personal fortune, at the disposal of a managed investment fund, or if you think you might like to try your hand at buying and selling a few securities yourself, there is always a place for new entries in the markets.