When searching for a financial advisor to guide you on decisions regarding retirement, investments, life insurance, estate planning and the like, you should treat it like an interview and have several questions prepared. One of the most important questions to ask is whether the advisor is a fiduciary. You might assume that a financial advisor always has the best interests of the client at heart. That, unfortunately, is not always true, and it is at the heart of the fiduciary rule.
What is a Fiduciary?
When a person or organization acts as a fiduciary, they are ethically bound to act in the best interests of the party whose assets they are managing. Such assets are managed to benefit their owner, not for the profit of the manager. In addition, there should be no conflict of interest between the fiduciary and the owner of the managed assets. A fiduciary has the duty of “loyalty and care,” which is another way of stating that the client’s interests are always put above their own.
Broker-dealers, on the other hand, operate differently. They are sales representatives, and while they must make “suitable” recommendations to clients, their primary loyalty is to the brokerage for which they work, not the client. They are also paid by commission for selling you a product, rather than being paid by you for their best advice and service. The confusing part is they can also call themselves "financial advisors".
While there are plenty of honest broker-dealers in the business, there are also those who will steer clients toward high commission offerings rather than those products with a low or no commission. For example, a broker-dealer could sell a client a mutual fund that charges a load (commission), while a similar no-load mutual fund may have an even better track record and is less expensive. An advisor acting as a fiduciary cannot do that. The Council of Economic Advisors found conflicts of interest led to 1 percentage point lower annual returns on retirement savings, on average. This is estimated to amount to $17 billion annually being lost by U.S. investors overpaying for such investment products.1
What is the Fiduciary Rule?
A fiduciary rule regarding full transparency has long been a practice of many financial planners and advisors, and in 2015 the Obama administration wanted to initiate investor reform via such a regulation. As proposed, the fiduciary rule would have required all financial firms to act as fiduciaries when dealing with clients’ retirement accounts.
The U.S. Department of Labor (DOL) was supposed to begin phasing in the rule as of April 2017, but the Trump administration issued a memorandum in February 2017 which delayed the rule’s implementation by six months. In June 2018, the U.S. Fifth Circuit Court of Appeals upheld an earlier decision to strike down the DOL’s fiduciary rule. The court’s majority found that the DOL did not have the required authority to issue a regulation changing the definition of a fiduciary. While the fiduciary rule is dead on the federal level for now, that does not mean it isn’t vitally important for consumers. You do not want to settle for "suitability" from a salesperson when searching for a financial advisor - work with a fiduciary.
Fiduciary vs. Salesperson
Many people think all financial advisors are fiduciaries, but that is not the case. Many large well-known firms call their salespeople "financial advisors". These salespeople are not fiduciaries and are more interested in selling a product than looking out for the client’s best interest. Even if a client understands a particular advisor is basically a salesperson, the person can still take advantage of the relationship. The fiduciary rule would have forced these salespeople to act as fiduciaries, and that was not a popular change among the many large firms that promote their salespeople as financial advisors.
One way to ensure you are working with a true financial advisor who is a fiduciary is to work with a "fee-only" advisor. Fee-only advisors are paid directly from their clients for their services and not for the products they sell. They do not receive other sources of compensation, such as commissions or payments from fund providers. "Fee-only" should not be confused with "fee-based". Fee-based advisors can still earn commissions and are not held to the fiduciary standard.
Asking the Fiduciary Question
When interviewing a financial advisor, inquire whether they are a fiduciary. Also ensure you know exactly how they are paid. If they make a commission, they are not a fiduciary. If you are searching for a financial advisor there are a number of associations that require their members abide by a fiduciary standard when working with clients. A few of these associations include the XY Planning Network (XYPN), the National Association of Personal Financial Advisors (NAPFA), the Garrett Planning Network, and the Alliance of Comprehensive Planners. So even though the fiduciary rule is not a law, do not settle for anything less than working with a financial advisor who is looking out for your best interests.
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This content is developed from sources believed to be providing accurate information. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.