The term “fiduciary” is a good thing to hear if you’re searching for a financial advisor. Perhaps you’ve heard it in the news in connection to the debate over the Department of Labor’s fiduciary rule, or maybe it cropped up as you were choosing a financial advisor. Financial advisors who are fiduciaries hold a relationship of trust with their clients and abide by fiduciary duty. Fiduciary duty is the ethical obligation to act solely in someone else’s best interest. In theory, this should minimize conflicts of interest and make a financial advisor more trustworthy. Read on to learn more about what a fiduciary is and what fiduciary duty entails, as well as how to find a fiduciary financial advisor to work with.
By definition, a fiduciary is an individual who is ethically bound to act in another person’s best interest. This obligation eliminates conflict of interest concerns and makes a fiduciary’s advice more trustworthy. Fiduciaries 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 by purchasing securities for their own account before buying them for a client.
The term usually refers to someone who manages assets on the behalf of an individual, a family or a company. This person might be a banker, accountant, executor, trustee, board member, financial advisor or investment professional. In theory, a fiduciary can be anyone to whom you delegate personal, legal or financial choices. In other words, it’s up to you to choose wisely.
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 put the other party’s interests first.
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 to 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. 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 averse to your best interests. Examples include:
- Account churning (making an excessive number of trades to make commissions)
- Misrepresentation (making a false statement about a security transaction)
- Making unauthorized trades
- Acting negligently
Fiduciaries can be held financially and civilly responsible for any actions they make that are not in your best interest. You are entitled to damages even if you don’t incur harm.
The Department of Labor Fiduciary Rule
The term fiduciary has repeatedly made headlines over the last few years thanks to the Department of Labor’s fiduciary rule. The rule required any financial professionals — including brokers and insurance dealers — who provide retirement advice or work with retirement plans to act as fiduciaries. The Obama administration proposed the rule to create greater transparency around retirement planning. The rule required financial professionals to disclose potential conflicts of interest and clearly state fees and commissions. The Obama administration said the rule could save Americans as much as $17 billion a year due to conflicted advice.
However, as of June 2018, the fiduciary rule is effectively dead. After President Trump took office, he delayed the rule’s implementation due to resistance from the financial industry. Opponents argued that the rule would make it more expensive for advisors to manage smaller accounts, in turn making it harder for lower-income investors to get financial advice. Then, in June 2018, the Fifth Circuit Court confirmed that it had finalized its decision to end the fiduciary rule. The court argued that the Department of Labor had overstepped its authority to regulate financial services and providers.
President Trump has requested that the Department of Labor look over the rule once again and prepare an analysis. The DOL could then ask the court to review the rule again, or the fiduciary rule could even make its way up to the Supreme Court. Regardless of what happens down the road, the Fifth Circuit Court of Appeals argued in its decision that the fiduciary rule “has already spawned significant market consequences” by increasing consumer awareness. Additionally, firms have already started changing their behavior, for instance by no longer selling products that don’t adhere to the fiduciary standard.
Why It’s Important to Choose a Fiduciary Financial Advisor
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, and they’re required to disclose any potential conflicts of interest that they do 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.
In general, 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 that are being made 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.
How Do I Know If a Financial Advisor Is a Fiduciary?
Not all financial advisors are fiduciaries. All investment advisors registered with the Securities and Exchange Commission or a state securities regulator must act as fiduciaries. 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’ interest before their own.
There are several resources available that can help you figure out if your 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. Garrett Planning Network is another planner organization of fiduciary financial planners that charge an hourly rate. The Certified Financial Planners Board also has an advisor search tool. You can also use its site to search a particular planner’s experience and history.
The vetting process shouldn’t stop there. Once you identify potential advisors, here are the sorts of questions you should ask to ensure that the advisor suits your needs and has 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 (SEC-filed paperwork). This will provide information about an advisor’s business, pay structure, educational background, potential conflicts of interest and disciplinary history. That information is also available online through the SEC’s Investment Advisor Public Disclosure tool. You can also request a performance record and list of client references to contact.
Suitability Rule vs. Fiduciary Duty
Some financial professionals such as brokers and insurance agents aren’t bound by fiduciary duty. Instead, they’re only required to fulfill a suitability obligation. While fiduciaries must put their clients’ best interests before their own, financial professionals who adhere to the suitability rule 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 they do you.
|Suitability Rule vs. Fiduciary Duty|
|Suitability Standards||Fiduciary Standards|
|Recommendations must be suitable for the client||Recommendations must be in client’s best interest|
|Less strict requirement regarding disclosure of conflicts of interest||Required to disclose conflicts of interest|
|May be loyal to the broker-dealer, not necessarily the client||Must be loyal to the client and act in good faith|
Are Robo-Advisors Fiduciaries?
A robo-advisor is a great alternative for investors who are just starting out and have less money to meet the account minimums and pay the higher fees charged by traditional financial advisors. But are robo-advisors fiduciaries? This is a question that’s up for debate in the financial industry.
Robo-advisors insist that they are fiduciaries. Robo-advisors are registered investment advisors, and most registered investment advisors are required to act in their clients’ best interests. Furthermore, robo-advisors that offer advice on 401(k)s must comply with ERISA’s fiduciary rules. Robo-advisors also don’t sell proprietary products.
The other camp argues that only human advisors can truly embody the fiduciary role.
Robo-advisors typically only offer investors advice based on their goals, rather than their full financial situation. This limits the scope of their advice and can make it less personalized than a traditional advisor’s.
The Bottom Line
When you’re working with a financial professional it’s key to find out if they abide by fiduciary duty. 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
- Narrow down your options with the help of a financial advisor matching tool like SmartAsset’s SmartAdvisor. The program asks you a series of questions about your financial situation, goals and preferences. Then, the program will match you with you to three nearby advisors who suit your needs.
- Before settling on an advisor, ask questions and do research. You should specifically ask if an advisor acts as a fiduciary. You should also ask about an advisor’s compensation structure. Fee-only financial advisors only earn money from the fees their clients pay. Fee-based advisors, on the other hand, can make money from selling products.
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