Clients rarely consider the custodian when picking an advisor. This is a mistake.
The custodian plays a critical role in asset safekeeping, transaction processing, investment access, and the overall cost and efficiency of the client’s financial relationship. Most importantly, the custodian holds and safeguards a client’s cash and securities, settles trades, processes deposits, withdrawals, wires, dividends, and interest, and maintains account and cost-basis records.
The custodian also controls the investment platform, including which mutual funds, ETFs, alternative investments, cash products, and lending services are available. This means, quite literally, you can only invest in products available on the custodian’s platform, and virtually every platform restricts products.
The three major custodians out there are:
- Schwab (popular with independent RIAs)
- Fidelity NFS (popular with larger wealth management platforms)
- Pershing (popular with larger wealth management platforms, but declining in popularity)
In addition, the largest banks typically have their own custodian. Finally, the wealth management platform LPL and retail platform Robinhood offer self-custody.
Choose Boring, Established Custodians: There are Catastrophic Risks if the Custodian Goes Bankrupt or Major Fraud
You REALLY do not want to be in a situation where your custodian goes bankrupt or where there is major fraud. Worst case, you could be out most of your investment, as SIPC insurance only covers $500K per customer.
Even if that is not the case, you will experience loss of account access until the securities are moved to a third-party custodian, which may take months. You may be faced with missing or incomplete records, which can create significant tax liabilities or result in real losses if securities cannot be accounted for.
Avoid Self-Custody: Gateway to Fraud
The number one reason Bernie Madoff pulled off his fraud was that he self-custodied. Because he self-custodied, he could manipulate client account statements. By separating custody from your wealth advisor, you create a system of checks and balances.
Additionally, by separating the two, you can easily self-audit your account statements.
Finally, if there is a concern about the wealth advisor and you want to freeze the account, it is straightforward to contact the custodian and notify them.
As a heads up, almost every firm that “self-custodies” technically uses an affiliate. For example, Robinhood uses Robinhood Securities. Just be aware of this, and do not assume that just because the name of the custody firm is different, it must not be self-custody. For example, the legal name for Fidelity NFS custody service is National Financial Services LLC.
I realize that some very large wirehouses, like Goldman, have self-custody, and that is just life. Goldman is (probably) not going to fake account holdings and account statements simply because they are too large and bureaucratic.
However, I do worry about smaller firms. For example, Robinhood self-custodies. I have always worried that they might misdirect client resources to shore up their own balance sheet, like during the GameStop debacle.
Limiting Your Investment Options for Their Benefit
A client may believe that their adviser has access to the entire investment universe of public investment options. The reality is that the adviser is limited to a menu established by the custodian.
Because the custodian controls the investment platform, it can decide which mutual funds, exchange-traded funds, separately managed accounts, alternative investments, and other products are approved for use. A product may be excluded even though it is publicly traded, liquid, appropriately registered, and potentially suitable for the client. Frequently, custodians limit access to improve their own economics.
Custodians frequently favor:
- Mutual funds and ETFs managed by an affiliated company
- Funds whose sponsors pay platform, distribution, data, marketing, or administrative fees
- Products offered by preferred strategic partners
- Investment strategies that generate greater revenue for the custodian
Even if the product is not excluded, the custodian may assess an onerous trading fee to discourage investment. For example, when I was CIO at Avantax, we used Fidelity NFS. Fidelity did not want us to invest in Vanguard products and assessed a $15 trade fee per account, whereas there was no cost for trading Fidelity or their preferred partners. I ended up with a $200K bill just from Vanguard trades from a quarterly rebalancing of client accounts. As a result, to control trading costs, we ended up replacing the Vanguard funds.
These restrictions can affect clients in several ways:
Higher Investment Costs
A proprietary or preferred fund may have a higher expense ratio than a comparable independent fund. It may also use a more expensive share class or impose additional distribution, servicing, or administrative expenses.
Even modest differences matter for a high-net-worth investor. A 0.25% additional annual expense on a $10 million allocation represents $25,000 per year before considering compounding.
Reduced Investment Choice
The best available ETF, mutual fund, money market fund, or alternative investment may not be available on the institution’s platform. The adviser may be required to select a less attractive substitute or recommend that the client open an account elsewhere.
Restricted product access can be particularly significant for clients seeking:
- Low-cost or specialized ETFs
- Institutional mutual fund share classes
- Independent money market funds
- Niche fixed-income strategies
- Tax-managed investments
- Alternative investments
- Private credit or private equity funds
- Foreign securities
- Emerging investment strategies
Conflicts of Interest
A conflict arises when the institution benefits financially from the product selected for the client. The custodian or an affiliate may receive management fees, shareholder-servicing payments, distribution revenue, platform fees, revenue-sharing payments, or other compensation.
Those arrangements do not necessarily mean that a product is inappropriate. However, they create an incentive to favor products that are more profitable for the institution over lower-cost or otherwise superior alternatives.
The economic relationship may also be difficult for a client to identify. Payments can be described as administrative, recordkeeping, networking, marketing, data, support, or platform fees rather than as direct sales commissions. Regardless of the label, the payments may influence which products receive access, visibility, or preferred treatment.
Limited Adviser Independence
An adviser employed by a bank or wirehouse may have less freedom than the client realizes. The adviser is likely prohibited from purchasing investments not on its custodian platform, even when the adviser believes it would better serve the client.
The wirehouses, such as Goldman Sachs or Merrill Lynch, may also establish sales targets, compensation incentives, product campaigns, or internal recognition programs that encourage the use of proprietary or preferred products. This can blur the distinction between objective investment advice and product distribution.
Restrictions on Alternative and Nontraditional Assets
Custodians may also limit or prohibit private equity, venture capital, private credit, hedge funds, direct real estate, closely held businesses, promissory notes, cryptocurrency, foreign securities, physical precious metals, and other nontraditional investments.
These limitations may lead to additional custody fees, fragmented reporting, duplicate accounts, valuation requirements, transfer delays, or the need to use a specialty custodian.
For example, while I was at Avantax, Fidelity NFS wanted to charge a 0.25% annual fee on our clients’ interval fund investments. This fee effectively made offering interval funds uneconomical for all parties (except Fidelity).
For a high-net-worth client, product access is therefore not merely an administrative issue. It can determine the investments available, the fees paid, the diversification achieved, and the degree to which the adviser can act independently.
A custodian should be evaluated not only by how securely it holds assets, but also by whether it provides open access to competitive investment products – or uses its control of the platform to steer client assets toward proprietary and preferred offerings.
Trading Friction: The Cost Hidden Behind “Zero Commissions”
Unfortunately, “zero-commission” trading does not mean that trade execution is free. The custodian or its affiliated broker generally controls where client orders are routed and will receive payment for order flow, exchange rebates, or other economic benefits from the market makers and trading venues that execute those orders. These arrangements create a conflict: the venue that pays the broker likely will not provide the client with the best available execution.
The Past 15 Years Have Seen the Rise of Zero Commissions
The resulting cost is difficult for clients to see because it rarely appears as a commission or account fee. Instead, it may take the form of a slightly higher purchase price or a slightly lower sale price. Even a difference of only a few cents per share can become significant across large portfolios.
This is particularly worrisome in the case Robinhood, because their whole model is built around selling trading flow from retail traders. I would be very concerned about trading friction.
Conclusions and Recommendations
As hopefully you can now realize, the custodian plays a significant role in wealth management, and a poor choice has significant negative implications.
As for my recommendations:
- The big three: Schwab, Fidelity NFS, and Pershing. Of these three, Schwab is my favorite, although I think Fidelity NFS is overall excellent as well.
- Rising star: Altruist. I consistently hear great things about them, and they have been growing like crazy.
- If possible, avoid the wirehouses (such as Goldman and Merrill Lynch) for custody because of the reduced investment choice and conflicts of interest.
- Avoid Robinhood. The savings from zero trading costs come at a high cost to the clients due to less efficient trading.
- Special situations: If you intend to heavily use margin, go with Interactive Brokers. They consistently offer great rates.
Crimson Wealth Management Can Assist with a Custodial Recommendation
We take into account your specific situation and make the right recommendation. Reach out to us to get started.