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In your search for a financial advisor, one of the most vexing words that you’ll come across is “fiduciary.” You’re likely to hear it a lot because the fiduciary issue is making news headlines.
What it Means
Let’s start with the basic meaning of the word. First of all, you may have noticed that “fiduciary” is both a noun and an adjective. An advisor can be a fiduciary, which as a noun means an asset manger who holds a legal or ethical relationship of trust between himself or herself and you, assuming you're the client.
Why is a fiduciary relationship so special?
When used as an adjective, “fiduciary” as in relationship, you place confidence, good faith, reliance, and trust in this fiduciary duty. It means by law the fiduciary investment advisor must always place the client’s interests above their own, regardless of any potential profit to the fiduciary. In other words, they offer unbiased advice.
Among lawyers and finance managers, a fiduciary duty is the highest standard of conduct. A fiduciary is expected to have undivided loyalty to the person to whom he or she serves, such that there is no conflict of interest between fiduciary and client.
Aren’t all advisors fiduciaries?
Not yet but regulators are hotly debating it right now, but the fact is most advisors are not. Instead, they use a different standard known as “suitability.” While it’s a subtle distinction, in some cases it can be very important. Under the standard of suitability, a financial advisor or asset manager is not required to place the client’s interests above their own in every case; instead, they’re obligated to recommend actions or investments that are merely “suitable” for their clients. These advisors, in most cases, get their paychecks from the commissions generated by your transactions. Clearly, your interests are not aligned. The suitability standard is not a code of ethics anyone would want an investment advisor to adhere to.
The suitability standard protects the advisor, not you
Here’s an example. Say you’re working with an investment advisor who is paid commissions and is in a position to recommend that you buy one of two annuities. Annuity A is an “in-house” product for which the advisor will earn a nice fat commission. Annuity B is an outside product for which the advisor will earn a much smaller commission. Your advisor recommends that you buy Policy A. Gee. Why? Is it really the very best choice for you, or is it a “suitable” choice and your advisor will earn that bigger commission payout? Most people never realize they may have just paid seven percent in commissions for an annuity they never needed. The advice was in the advisor’s best interest. Using a suitability standard, the advisor can defend his recommendation. On the other hand, the fee-only fiduciary advisor isn’t likely to recommend any investment unless it really is the very best choice for you. There’s no profit motivation. Sounds like the fiduciary role protects you from bad behavior. Well, that’s the way it should work.
This is a no-brainer, the fiduciary standard is better
Yes absolutely, with the understanding that the fiduciary mantle is only as good as the advisor who wears it. The fiduciary as a standard is an obvious better choice because it’s a higher legal hurdle. Not so simple when you’re applying standards to human behavior. Investment advisors operating under this higher standard can still be completely incompetent or even dishonest as an investment manager. Relying on the fact that your advisor is legally operating in your best interest can give you a false sense of security.
One name will make this very clear: Bernie Madoff.
It’s an extreme example, but you get my point. On my television series, MoneyTrack on PBS, I’ve interviewed dozens of victims scammed by brokers who were not fiduciaries but also by investment advisors who were operating as fiduciaries. Madoff was a broker for most of his career—a position that does not require a fiduciary duty—but when he registered as an investment advisor in 2006, he took on a fiduciary duty to his clients.
Bernie’s the poster child to illustrate that fiduciary status doesn’t guarantee honesty. At the end of the day, fiduciary status cannot guarantee any level of competence. Operating under this higher standard does make an advisor more accountable and is something an investor should ask about as part of their screening process. Just don't rely on it as the only choice of advisor. The fiduciary standard is intended to protect you. And at the same time, I know some excellent, skilled advisors who put clients first but work for firms still operating under the lessor suitability standard.
The Educated Consumer
What can you do to gate out potential abuses, bad behavior and conflicts of interest? It’s best to ask really good questions of the advisor you’re interviewing. Ask him or her point blank: Are you a fiduciary? Show me, in writing what I will pay in fees—all in. Explain how you make investment choices. Do you sell any investments under your own company’s brand name, or that your firm has packaged where you earn a commission? Even if and advisor claims to be an independent, it doesn’t mean they’re not beholden to a brokerage firm. Ask how much of his or her income comes from commissions. It’s all about transparency.
Separate the assets from the advisor
Make sure whatever assets your advisor is assigned to invest or oversee are held at a separate, independent institution, typically a well-known custodian (think: bank or name-brand brokerage). Your investments need to be separated from your advisor’s firm to make sure there are always two separate statements that agree and support the advisor’s performance reports.
Personally, if I were interviewing an advisor for the very first time, the fiduciary question would come up right away. To me, it just makes sense that professional advisors operate under rules requiring them to act as fiduciaries when they manage other people’s money. But with all the scams I’ve seen, by no means would I rely on the fiduciary label alone. There are a lot of qualified professionals who can help you accomplish your goals. Some are RIA's, some work for large institutions. Don't expect brokerage houses to adopt the fiduciary standard anytime soon. Interview your potential advisor asking very pointed questions. Fiduciary or not, you’re smart to thoroughly vet any advisor before signing on.