I remember so well something my college business law professor said one day when we were discussing the clear-cut nature of corporate malfeasance. “You’re either guilty or you’re not” he told us. “Just like you can’t be a little pregnant… you either are or you ain’t”
You run into the same either-or condition when you try to pick the right financial advisor.
They are either fiduciaries or ‘they ain’t!’ One of the first things you should ask an advisor is: “Do you work under the fiduciary standard?”
What is the fiduciary standard? It’s a requirement spelled out in the Investment Advisers Act of 1940 and regulated by the Securities and Exchange Commission (SEC) or state securities regulators that says financial advisors must place their clients’ interests ahead of their own. Ask your potential advisor if he or she acts under the purview of the SEC or state regulators, as opposed to the Financial Industry Regulatory Authority (FINRA) and has no conflicts of interest. If so, chances are the advisor is acting appropriately as a fiduciary.
A fiduciary, as Investopedia defines it, must do his or her best to give you investment advice is using accurate and complete information, avoid any conflict of interest, and should trade securities for you with the best combination of low cost and efficient execution. Fiduciaries charge you fees for their services rather than taking commissions—so that you’ll never have to wonder if they’re recommending a product just because it will pay them a fat percentage.
It would seem like a no-brainer that if you entrust someone with your money they should be looking out for you, wouldn’t it? Not so fast. It doesn’t apply to all financial advisors.
There are broker-dealers who invest your money for you under a different standard, the one set by FINRA known as “suitability.” Here’s the Investopedia definition of the suitability standard: it requires only that broker-dealers must reasonably believe that any recommendations made are suitable for clients, in terms of their financial needs, objectives, and unique circumstances. Broker-dealers serve their firms before their clients—i.e. their first obligation is to make money for the firm.
You may have heard that there’s controversy in Washington over extending the fiduciary rule to retirement plans and retirement advice planning. That just makes it all the more important that if you want a financial advisor who will give you unbiased guidance on your financial goals, make sure he or she is bound to the fiduciary standard.
It helps to understand why the industry has split into these two separate paths. In the old days, it was simple. There was one pricing model. People who sold securities got paid by commission on what they bought or sold on behalf of their client.
But in the 1970s, the financial services industry began to offer financial planning services based on fees instead of commissions, partly as an attempt to help consumers wade through the exotic pricing structures that mutual funds had created by then. Management fees, operating expenses, 12(b)1 fees—you know these terms if you’ve ever tried to read a mutual fund prospectus. For some, the fee-only option was a revelation and an opportunity to bring lower costs to clients and focus on offering financial planning advice and broadening services beyond simply selling investments.
The commission institutions (think the big wire houses−you know their names−and other brokerage firms) began to see their market dominance being threatened by the new fee-oriented planning structure. So they created their own wrap accounts and charged their customers fees. But what they didn’t tell or show clients was the internal self-dealing and profits made by trading with their own accounts along with their client portfolios. Fiduciaries, on the other hand, are prohibited from buying securities for their own accounts before they buy them for clients.
The financial industry is feeling the heat these days and has answered with great commercials declaring their humanity and care for their customers. But commission institutions have also fought back the fiduciary standard requirement, to their benefit and the detriment of consumers.
It’s a pretty distinct line between being a fiduciary and being a broker making decisions based on his or her perception of “suitability.” Your advisor either IS or ISN’T acting in your best interests.
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