When managing your wealth, it’s essential to understand who has your best interests at heart. A fiduciary is someone legally obligated to act in your best interest. But why does this matter?
What is a Fiduciary and Why Should I Care?
Did you know that employees are fiduciaries to their employer and are legally bound to act in the best interest of their employer? Now, that doesn’t necessarily mean that a salesperson or other employee is out to get you. In many cases, you could argue that acting in the best interest of the client or customer is in the best interest of the employer. Certainly, it helps build customer satisfaction and trust, often leading to additional business for the employer.
Certain businesses become fiduciaries to their customers when they enter into an engagement. Take financial advisors, for instance. Not all of them work under the same rules. Registered Investment Advisors, or RIAs for short, are fiduciary firms*, meaning they are legally bound to act in your best interest at all times. This contrasts with financial professionals working under a “suitability standard” who are only required to recommend products suitable for you – not necessarily the best for you.
*The Registered Investment Advisor (RIA) is the firm and the Investment Advisor Representatives (IARs) are the advisors, the humans who provide advice while working for an RIA.
The Difference between Fiduciary Standard and Suitability Standard
The fiduciary standard says that the RIA must act in the best interest of the client, not the best interest of the RIA. Conflicts of interest must be minimized and disclosed. You’ll often see an effort to align the interests of the RIA and the client. This is where you hear statements like “We do well when you do well.”
A suitability standard means that a broker must have a reasonable basis to believe that a recommendation is suitable for at least some investors and that, based on the client’s investment profile, it is suitable for the client. The difference is that a recommendation only needs to be suitable, not necessarily in the best interests of the client.
Here’s a simple analogy: Imagine you’re shopping for an outfit for an important interview. A salesperson could sell you an expensive, slightly snug, yellow and orange tuxedo, which you could technically wear to the interview. But it’s not in your best interest when a well-fitting, professional suit (maybe with a lesser commission) would be a much better choice.
A more likely example would be an instance where a choice needs to be made between two mutual funds for a client’s portfolio. In this case, let’s assume both funds would serve the same purpose in the portfolio. However, one fund has a higher expense ratio than the other. And the more expensive fund pays a higher commission to the agent. If the agent recommends the fund with a higher commission, are you confident that the fund was recommended because it was the best choice for you or because it was the best choice for the agent? Keep in mind that the agent needs to earn a living, too, and they will be compensated for the sales of a fund either way.
In short, the difference with a fiduciary advisor is that you will likely be paying the advisor for their advice rather than a company compensating an agent for selling its product, and the amount you pay the advisor is not likely dependent on the mutual fund being recommended.
Should you always work with a fiduciary?
So, here’s the thing. Sometimes, you’ll need a financial product that is only sold by agents who work on a suitability standard. Despite articles you may have read or pundits you may have heard, not everyone who works on a suitability standard is out to scam their customers. While I am now only a fiduciary to my clients, when I worked on a suitability standard, I still made sure to make recommendations in my client’s best interest because I simply believed (and still do) that it was the right thing to do.
Helping people build the financial future of their dreams is why I got into this business, and that requires making recommendations that are in their best interests. Many brokers and agents have the same belief system regardless of the standard they work under.
Keep in mind that these are regulations, and there are far too many examples of people who are legally bound to act in their client’s best interests and who have broken the law. In fact, Bernard L. Madoff Investment Securities LLC was a Registered Investment Advisor. That’s right – Bernie Madoff. Being bound by a fiduciary duty to his clients did not prevent him from engaging in one of the biggest financial Ponzi schemes in history.
So what should you do?
Research the company
Do your research.
You should always research the firm and the individual providing the recommendations. And be aware of any complaints made against either party.
Know their role
Something else to consider is that some people who provide recommendations can be both a fiduciary and an agent, depending on which “hat they’re wearing” when they make the recommendation.
For instance, a Registered Investment Advisor who is managing your investment portfolio must act as a fiduciary. But, that firm’s advisors might also have licenses allowing them to sell variable annuities. The same person who has a fiduciary duty to you while managing your portfolio may not have a fiduciary duty to you when selling you an annuity.
Understand the fee structure.
Ask about fees
It is important to ask the advisor about all the fees associated with a recommendation. You should also ask what other options were considered and why the advisor settled on the recommended option. You should also ask how the advisor/agent is being compensated. In fact, the advisor/agent must usually disclose the compensation they will receive for the product being sold. You can also ask what compensation would have been associated with the options that were not ultimately recommended. Pay close attention to any features added to a financial product and ask questions if you don’t understand how they pertain to your financial goals.