Is Your Financial Advisor a Fiduciary?
You may have heard the word “fiduciary” when searching for a financial advisor. This is an important term to understand, and we’ll break down why it’s so critical to work with a fiduciary. But first, the fiduciary meaning: A fiduciary is an individual or organization that has a legal duty of loyalty and care to another person (or persons).
A fiduciary who manages money for another person is expected to act with the utmost honesty and integrity, making decisions that are in that person’s best interests. Bankers, attorneys, money managers, financial advisors, accountants, executors, board members, and corporate officers should have fiduciary responsibility. If they are, and it can be proven they haven’t acted in the best interest of their customers, clients, or shareholders, they can be held legally liable.
What is Expected of a Fiduciary?
When searching for a financial advisor, look for a fiduciary. Trust is crucially important in a relationship, and you deserve an advisor who is transparent and minimizes conflicts.
Fiduciary financial advisors must:
Put your best interests before their own, seeking the best prices and terms
Act in good faith and provide you with all relevant facts
Avoid conflicts of interest and disclose any potential conflicts of interest
Do their best to ensure the advice they provide is accurate and thorough
Avoid using your assets purely to benefit themselves, such as by purchasing securities for their own account before buying them for you
Understanding Fiduciary Duties
A fiduciary’s responsibilities are both ethical and legal. When a party knowingly accepts the fiduciary duty, they are required to act in the best interest of the principal, the party whose assets they are representing. If someone has a fiduciary duty to you, he or she must act first and foremost in your financial interests. A fiduciary cannot recommend an investment that doesn’t benefit you or carries higher fees than a virtually identical investment.
On the contrary, non-fiduciaries may consider their own interests alongside yours and recommend investments that pay them the largest commissions — as long as the investment is generally considered suitable for your needs.
Recourse is another important consideration. If a fiduciary violates his or her duty, you have an avenue for legal action. If a non-fiduciary advisor knowingly sells you high-fee or inappropriate investments, you’ll face much greater difficulty proving legal wrongdoing.
Here are common examples of breaches of fiduciary duty:
Making unauthorized trades
Account churning (making excessive trades to generate commissions)
Misrepresentation (making a false statement about a security transaction)
How Do You Know If Your Financial Advisor is a Fiduciary?
Vet candidates carefully. Get to know any financial advisors you are considering and ask questions to ensure they are suitable for your needs. Here are good questions to ask.
1. Are you a fiduciary?
Only financial advisors who are fiduciaries are required by law to follow the fiduciary rule and act in the best interests of their clients, both on retirement and other investment accounts.
2. Do you have an adequate investment in technology?
Many registered investment advisors (RIAs) haven’t made adequate investments in technology, such as basic financial planning advisors. You should seek an independent RIA who has the software to provide a transparent view of your entire financial life. Otherwise, how would he or she be able to provide you with holistic financial and investment advice?
3. How are you compensated?
It can be tough to find out how an advisor or broker is compensated. Brokers can be incentivized by mutual fund incentives, lending products, and trading commissions. These costs are often buried in fine print, but they can really add up if you’re not careful.
Personal Capital was built around the fiduciary standard. We are – and always will be – a fiduciary for our clients. We promise to provide advice that is in our clients’ best interest, and because we are a Registered Investment Advisor (RIA), it is our legal obligation, as well.
Suitability Standard vs. Fiduciary Duty
Financial advisors are held to different standards depending on their job title, certifications, and more. As we’ve mentioned, those professionals that are held to a fiduciary duty are required to act in the best interests of their clients. In addition to providing accurate and thorough advice, fiduciaries must put their clients’ interests above their own.
Certain financial professionals are automatically held to a fiduciary standard. Under the Investment Advisers Act of 1940, all registered investment advisors (RIAs) are required to provide the fiduciary standard of care.
Certified Financial Planners (CFPs) are also automatically held to a fiduciary standard. The CFP Board requires a uniform fiduciary standard of conduct for all certified individuals, per its Code of Ethics and Standards of Conduct. Any planner who fails to act with a fiduciary standard of care risks losing their CFP credentials.
But as we’ve mentioned, not all financial professionals are required to follow a fiduciary standard. Advisors who don’t meet the criteria of someone required to act as a fiduciary — which is often the case for broker-dealers — must follow only a suitability standard governed by the Financial Industry Regulatory Authority (FINRA).
Under the suitability standard, advisors must recommend investment products they believe, based on their reasonable diligence and their client’s investment profile, to be suitable for that customer. However, as long as the product is suitable, it doesn’t necessarily have to be in the best interests of the client. Additionally, an advisor can’t make an excessive or unsuitable number of transactions as a way of racking up more commissions.
To help you fully understand the difference between a fiduciary and suitability standard of care, let’s use an example. Suppose there are two different investment products an advisor could recommend to a client. The two products are very similar, but one has considerably higher fees, as well as a higher commission for the advisor.
Under a fiduciary standard of care, the advisor would likely have to recommend the product with a lower fee, even if it means a lower commission for them. However, an advisor held to the suitability standard could recommend the product with a higher fee as a way of earning a higher commission.
Why It’s Important to Choose a Fiduciary Financial Advisor
A fiduciary advisor can give you greater peace of mind with your money. You’ll know they’re legally obligated to act in your best interests. By removing the incentives that underlie far too many high-fee and other proprietary investment products, and bypassing the people who push them, you’re more likely to end up with a strategy that is truly right for you.
Learn More About Personal Capital’s Wealth Management Services
Erin Gobler contributed to this article.