In legal terms, a fiduciary is an individual or organization that has taken on the responsibility of acting on behalf of another person or entity with honesty and integrity. For example, bankers, attorneys and officers of public companies are all fiduciaries, meaning they must act in the best interest of their customers, clients or shareholders. If they don’t, they are legally liable. Similarly in the investment world, fiduciary financial advisors manage client assets with their best interests in mind. To find a local fiduciary financial advisor, try using SmartAsset’s free tool.
Definition of Fiduciary
The term “fiduciary” can be defined as an individual or entity that acts on behalf of someone or something else. In this role, the fiduciary must operate as if they are who they represent, in an effort to make decisions that are in their best interest. In many cases, there are laws that surround the role of a fiduciary.
Fiduciary is a good word to hear when you’re searching for a financial advisor. An advisor that calls themselves a fiduciary seeks to minimize conflicts of interest, be transparent and live up to the trust placed in them. More specifically, fiduciary financial advisors must:
- Put their clients’ best interests before their own, seeking the best prices and terms.
- Act in good faith and provide all relevant facts to clients.
- Avoid conflicts of interest and disclose any potential conflicts of interest to clients.
- Do their best to ensure the advice they provide is accurate and thorough.
- Avoid using a client’s assets to benefit themselves, such as purchasing securities for their own account before buying them for a client.
Fiduciary usually refers to someone who manages assets on the behalf of an individual, a family, a company or any other entity. In addition to a banker or financial advisor, this person could be an accountant, executor, trustee or board member. In theory, a fiduciary can be anyone to whom you delegate your personal, legal or financial choices.
What Is Fiduciary Duty?
Fiduciary duty is a legal responsibility to put the interests of another party before your own. If someone has a fiduciary duty to you, he or she must act solely in your financial interests. A fiduciary cannot, for example, recommend a strategy that doesn’t benefit you but instead provides a kickback. You can think of it like the doctor-patient relationship, where one party has a duty to provide the best care it can to the other party.
Fiduciary duty is important for guiding the actions of the professionals who deal with clients’ money. It’s also important because, when violated, it provides an avenue for legal action. If a financial professional who isn’t a fiduciary has been knowingly selling you low-performing, high-fee investments, you don’t have the legal standing that you would have if the professional were a fiduciary.
A breach of fiduciary duty occurs when a fiduciary fails to honor his or her obligation. They can be held financially and civilly responsible for any actions they make that are not in your best interest. A breach could happen if a fiduciary benefits from his or her recommendations, fails to provide proper guidance or acts in any way that’s adverse to your best interests.
Examples of a breach of fiduciary duty include:
- Account churning: For financial advisors, this can include making an excessive number of trades to earn commissions.
- Misrepresentation: In the case of a financial advisor, this could involve making a false statement about a security transaction.
- Making unauthorized trades: For example, if a financial advisor manages your assets discretionarily and doesn’t ask for your approval before trading.
- Acting negligently: This basically covers any breach of fiduciary duty outside of the above.
What Are the Different Types of Fiduciary Relationships?
The term “fiduciary” applies to an incredibly diverse range of situations. As a result, there are a number of different types of fiduciary relationships. We detail some of the most prominent ones below.
Financial Advisors and Their Clients
When you begin a working relationships with a financial advisor, you essentially give them access to your money and investments. Furthermore, many advisors have discretionary control of your assets, which means they can make decisions on their own, without your approval.
Because of this, an advisor’s role as a fiduciary is incredibly important. You need to be able to trust your advisor explicitly that they are making investment decisions that are in your best interest. In addition, if your advisor tries to sell you something, like an insurance policy, you need to trust that they believe it’s the right one for you.
Guardians and Wards
In the eyes of the law, a minor cannot make many decisions on their own. In turn, a government will appoint a guardian to be their decision maker. To trust a guardian, the government appointing them must feel that they will put the ward’s best interest first until they come of age. That’s why guardians are considered fiduciaries in the eyes of the law.
Boards and Shareholders
In the corporate world, board members are in charge of managing the direction in which a company goes. Because companies are often owned by a pool of shareholders, these board members must act as a fiduciary when making these decisions. This is done to protect shareholders from a board that could potentially choose things that somehow benefit themselves.
In order to meet its fiduciary standard, board members are required to probe every possible option that’s available to them. By doing this, shareholders can feel confident that every potential avenue was explored before a final decision was made.
Lawyers and Their Clients
The attorney-client relationship is one of the most fiduciary dependent ones there is. Lawyers and those they represent have incredibly close relationships, with important information being shared in both directions. In turn, if a lawyer breaches their fiduciary duty, it’s an incredibly serious offense.
How to Find a Fiduciary Financial Advisor
All investment advisors registered with the U.S. Securities and Exchange Commission (SEC) or a state securities regulator must act as fiduciaries. On the other hand, broker-dealers, stockbrokers and insurance agents are only required to fulfill a suitability obligation. This means that while they must provide suitable recommendations to their clients, they don’t have to put their clients’ interests before their own.
There are several resources available that can help you know if an advisor is a fiduciary. The National Association of Personal Financial Advisors (NAPFA) has an online search tool that makes it easy to find certified financial planners in your area. Every advisor in that system operates on a fee-only basis and promises to act as a fiduciary. Additionally, the Certified Financial Planners Board has an advisor search tool.
The vetting process shouldn’t stop there, though. Once you identify potential advisors, here are the sorts of questions you should ask advisors to ensure that they suit your needs and have minimal conflicts of interest:
- How do you earn money?
- What certifications and licenses do you hold?
- What services do you offer? Who is your typical client?
- How often do you typically communicate with clients?
- Can you provide a written guarantee of your fiduciary duty?
You should also request a copy of a financial advisor’s Form ADV and Form CRS, which is paperwork the SEC requires advisory firms to file. This will provide information about an advisor’s business, pay structure, educational background, potential conflicts of interest and disciplinary history. This information is also available online through the SEC’s Investment Advisor Public Disclosure (IAPD) tool. You can also request a performance record and list of client references to contact.
Note that robo-advisors that hold a registration with the SEC are also inherently fiduciaries. As registered investment advisors, they are required to act in their clients’ best interests. Furthermore, robo-advisors that offer advice on 401(k) plans must comply with ERISA’s fiduciary rules.
Fiduciary Duty vs. Suitability Rule
Some financial professionals, such as investment brokers and insurance agents, don’t abide by a fiduciary duty. Instead, they only have to fulfill a suitability obligation. While fiduciaries must put their clients’ best interests before their own, financial professionals who adhere to the suitability standard must only provide suitable recommendations to their clients.
To determine whether a recommendation is suitable, these professionals must consider your financial situation, goals and risk tolerance. Additionally, they must ensure that you won’t incur excessive costs and that excessive trades won’t be made. However, they may still suggest products that aren’t necessarily in your best interest or that benefit them more than you.
Here’s a comparison of fiduciary duty and the suitability rule:
|Suitability Rule vs. Fiduciary Duty|
|Rules||Suitability Standards||Fiduciary Standards|
|Recommendation Requirements||Recommendations must be suitable for the client||Recommendations must be in client’s best interest|
|Disclosure Requirements||Less strict rules regarding disclosure of conflicts of interest||Required to fully disclose conflicts of interest|
|Loyalty Requirements||May be loyal to the broker-dealer, not necessarily the client||Must be loyal to the client and act in good faith|
Why Working With a Fiduciary Financial Advisor Is Important
Choosing a fiduciary financial advisor can give you greater peace of mind. With a fiduciary financial advisor, you’ll know that the person managing your money must make decisions in your best interest. In general, fiduciary financial advisors tend to have fewer conflicts of interest. However, they legally must disclose any potential conflicts of interest that they have.
Financial professionals who earn commissions may be incentivized to sell their own products even if there are comparable products available at a lower cost. Fiduciaries must seek the best prices and terms for their clients. Thus, if you work with a fiduciary you’re more likely to end up with the product or recommendation that’s truly right for you.
For the most part, financial professionals bound by fiduciary duty tend to be more transparent. Fiduciaries must thoroughly discuss their decisions with their clients, providing all relevant information and pertinent facts. This makes it easier to ensure you understand the decisions in regards to your assets and financial future.
While not all non-fiduciaries are necessarily bad actors, it’s easier to ensure that you’re working with someone who has your best interest if you opt to work with a fiduciary. Moreover, if you’re working with someone who doesn’t have a fiduciary duty to you, you have fewer legal options in the event that you discover your interests haven’t been served.
When you’re working with a financial professional, it’s key to find out if he or she follows the fiduciary standard. A fiduciary has different obligations than someone bound only by the suitability rule. Fiduciaries must always act in their clients’ best interest – and if they don’t, you have legal options to pursue. Ultimately, when it comes to choosing someone to manage your money, you should find someone you can trust.
Tips for Finding a Financial Advisor
- Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Talk to at least three candidates before settling on one. That way, you’ll have enough context about fees, services and investing strategies to choose with confidence.
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