With the abundance of complex information in the financial world, getting the best financial advice is challenging. As a client, how do you know that your financial advisor has your best interests in mind?
Oftentimes, firms and advisors attempt to differentiate themselves as fiduciaries, or people who judiciously take care of money or other assets for their clients. This article is about what a fiduciary financial advisor is, the difference between fiduciary and suitability standards and what you should focus on as a client while planning your financial future.
The Evolution of the Fiduciary Rule
The term “fiduciary” applies when one person places confidence and trust in someone else and seeks that person’s advice. However, its meaning for investors continues to shift. The Department of Labor heightened the awareness of fiduciary duty with its Fiduciary Rule in 2016. And varying standards apply to different advisor types including retirement, investment, the CFP Board for financial planners, and various member organizations.
President Biden’s administration approved the latest version of The Fiduciary Rule. Now financial advisors fall into two camps: fiduciaries and non-fiduciaries. The crux of the matter for some is that both sales brokers and fiduciary advisors can call themselves “advisors.”
The Fiduciary Standard, Suitability Standard and Hybrid Advisors
I'm not here to stir the pot with “one side is good, and the other is bad.” I have brokers in my circle of trusted friends because they are straight shooters. However, there are advisors to whom I’d give a wide berth because they are not.
Fiduciary Standard: According to the Cornell Law Dictionary, “Fiduciary duty is the highest standard of care.”
- Registered Investment Advisors must wear a fiduciary-standard “hat” regulated by the Securities and Exchange Commission, or a state security regulator must act in the client's best interest 100 percent of the time.
- Advisors must abide by a duty of care and loyalty that constitutes ethical and client-first advising enforced by the SEC.
- They must also act in good faith, providing relevant facts to clients, avoiding and disclosing potential conflicts of interest and using accurate, complete information, so the analysis is as thorough as possible.
- Those that are 100% fee-only fiduciaries are compensated by “fee only.” They can't charge or accept any commissions from any investment products. They are also prohibited from participating in reimbursements from third parties.
- Some advisors are not required to act in a fiduciary capacity: This includes registered representatives of Wall Street broker-dealer firms and insurance companies, who are often paid commissions.
- This standard also applies to advisors who sell “suitable” products to clients. In layman’s terms, they are not required to act in their clients’ best interest when recommending investment products. A dilemma arises when two or more products are suitable, and interest conflicts arise when investments pay different commission structures.
Hybrid Advisors: Some advisors work for firms that allow them to float between the two standards.
What Clients Need to Focus On:
- As a client, it’s incumbent upon you to prioritize your goals and be responsible.
- Not everyone needs a fiduciary. Sophisticated investors might be well served with order execution, which is the process of accepting and completing a buy or sell order in the market on behalf of a client.
- Trust everyone but cut the cards. If you need advice, do your homework because not all fiduciaries are created equal.
- The easiest way to determine if your advisor is a fiduciary in all areas of your engagement (e.g., investing and planning) is to ask. If they’re not, ask why. You should get a clear, concise and logical answer. Ask how they’re compensated, and if they’re commission-based, ask how they manage conflicts of interest.
The financial services industry tends to promote confusion. I know this can be frustrating. Regardless of your situation, I’d lean toward working with financial professionals who follow fiduciary standards. This way you’ll know that they are held to higher standards on your behalf.
No matter which standard your advisor falls under, there's a big difference between good and great. In Sir William Oster’s words, “A good physician treats the disease. The great physician treats the patient who has the disease.” This applies to the world of finance as well.
Remember, your financial professional’s credentials are just part of the story. Their experience is an essential second layer. Finally, their ethical standards must be clear: How do they perform when no one is looking? Your financial future dictates everything in life. You deserve to be well-served in the hands of a caring, empathetic (and even telepathic) financial advisor. May this sage advice help you secure your financial future wisely.