And Higher Still: Financial Advisors and Fiduciary Duty

While you'll encounter all sorts of acronyms in the wild, there are really only two flavors of financial advisors: those bound by the fiduciary standard and those not bound by the fiduciary standard. The definition of the term: "from the Latin fiducia, meaning 'trust,' a person (or a business like a bank or stock brokerage) who has the power and obligation to act for another (often called the beneficiary) under circumstances which require total trust, good faith and honesty." Basically, a fiduciary is legally obligated to act in your best interests.

Sounds like that should apply to all financial advisors, right? Unfortunately, it does not.

Who Must Act In Your Best Interests?

Registered Investment Advisors (RIAs) must always adhere to a fiduciary standard; Certified Financial Planners (CFPs) must usually adhere, but many employ 'dual registration' as broker-dealers to skirt these requirements. The most common type of financial advisor—the registered broker-dealer—is completely excused.

A fiduciary is required to act in ways that are most beneficial to their clients, all the time and to the best of their abilities; everyone else is bound only by the 'suitability standard', which vaguely states that the financial products they recommend must be 'suitable'. This is because broker-dealers are actually salesmen, paid on commission by a bank, brokerage, or insurance company; those acting as fiduciaries, on the other hand, typically charge a fee for their advice and never receive a kickback for their recommendations.

If your investment charges fees above 0.50% per year or has any sort of sales load, you are getting ripped off.

Stay away from advertisements disguised as free advice—if they're not asking for money up-front, they're getting it from you somewhere else.

Our old friend John Bogle has fought tooth-and-nail for a broad, unified fiduciary standard for the financial services industry.

Ask Hard Questions

When shopping for a financial advisor, ask them the following questions:

“In our interactions, will you be acting as a fiduciary? Will you be bound by fiduciary duty?”
“What is your commission and recruitment structure? How are you compensated by the company you work for and by the companies whose products you recommend?”

Choose an advisor bound by fiduciary duty who charges a flat rate or fixed percentage of assets (i.e. a ‘wrap fee’); avoid broker-dealers and anyone paid on commission.

Follow Your Gut

Broker-dealers pushing insurance products, such as annuities, generally have the most to gain from fees and commissions. They will often use hard-sell approaches, such as setting arbitrarily short deadlines, to create artificial urgency and pressure you into making a decision. They may also play up the work that they have done to prepare a policy in an effort to make you feel bad about turning down their offer. Don't be fooled by these unethical approaches.

Always fall back on these investment sanity checks:

"Never invest in something you don't understand."
"If it sounds too good to be true, it probably is."

If something fails these checks, get more information. Do your homework: watch out especially for fees and hidden risks.

If your interactions with your financial advisor make you feel uncomfortable, find a new advisor. Most people with straightforward finances who follow a simple index mutual fund investment strategy can confidently manage their investments themselves, only seeking out tax and regulatory advice from a professional as-needed.

2013-10-16

Financial Advisors and Fiduciary Duty

Who Must Act In Your Best Interests?

Ask Hard Questions

Follow Your Gut

Further Reading