What is a Fiduciary?
Shedding some light on an industry term
In the search for a financial advisor, you may come across a common buzzword: fiduciary. A welcome sign when used as a descriptor for a financial professional, fiduciary refers to those required by law to act in the best interest of their clients, even if doing so means putting their clients’ interests ahead of their own.
While it may seem obvious that financial professionals should act in the best interest of their clients, this is unfortunately not always the case. While not all conflicts can be avoided when giving investment advice, the White House’s Council of Economic Advisors estimated in 2015 that conflicted advice cost American investors $17 billion a yeari. Yet nearly half of Americans falsely believe that all financial professionals are legally required to act in their best interest, when in fact only those with the fiduciary designation are held to that standard. While non-fiduciary advisors may have moral reasons to act in the best interest of their clients—and many will strive do so—they are not legally obligated to.
Part of the confusion comes down to terminology—particularly with the term “financial advisor” itself. Financial advisors often fall into one of two main categories: investment advisor representatives affiliated with a registered investment advisor (RIAs) or registered representatives with a broker-dealer.
- RIAs are registered with and regulated by the Securities and Exchange Commission (SEC). Financial advisors who work for an RIA are held to a fiduciary standard of care for their clients.
- One additional step an investment advisor may take is receiving the Certified Financial Planner (CFP®) designation. Certified Financial Planners must meet four categories of requirements: education, examination, experience, and ethics, as well as adhere to the CFP Board Code of Ethics and Professional Responsibility.
- Broker dealer registered representatives are licensed to sell investment products and may collect commissions for those products. Registered representatives are held only to a “suitability” standard—described below.
In 2018, the SEC proposed regulation that would prohibit registered representatives from calling themselves advisors, though with a loophole: the proposed rule overlooks reps with dual registration as both brokers and advisors.
Suitability vs. Fiduciary Standard
For advice from a financial professional to be “suitable,” it must be backed by the belief that the recommendation is appropriate given the client’s unique financial needs, objectives, and circumstances.
The suitability standard, while nice in theory, still allows for conflicts such as compensation or fees a representative receives. For example, a non-fiduciary advisor might hold the belief that an expensive product is suitable given his or her client’s profile, and it could be the case that the advisor receives a commission for selling that product. That advisor would not be obliged to sell a similarly suitable product that was less expensive. A fiduciary, while not automatically immune to conflicts, would be legally bound to seek the equivalent lower cost product as it would be in the client’s best interest.
How are Fiduciaries Paid?
Different fee structures also set advisors apart; advisors can be compensated through fees (charged by the hour or a percentage of their client’s portfolio), commissions, or a mix of both. By law, fiduciaries must be fee-based or fee-only. That means they are only paid for their financial advice rather than receiving commissions for buying or selling investment products or for conducting transactions. This helps fiduciary advisors reduce conflicts of interest. Commission-based representatives, on the other hand, carry the potential for biased advice, as their compensation model means they may receive commissions for recommending certain products or collect fees for generating transactions.
The Fiduciary Difference
Not all advisors are equal. Beware of vague terms like “trusted advisor,” as they do not equate to fiduciary. To be clear on where your advisor stands, ask questions about their compensation model or directly confirm that they are a fiduciary and will put your interests above their own.
While we are a bit biased given our own fiduciary model, we believe there’s additional peace of mind that comes with a fiduciary advisor. With a fiduciary, you know that he or she is legally required to have your back. You can bestow complete trust in your advisor and even give him or her discretionary authority over your assets because you know that decisions made will always be aligned with your interests.
[i] Obama White House Archives February 2015