Not all financial advisors are the same. An important distinction is whether they adhere to the fiduciary standard.
When a financial advisor is a fiduciary, he or she has a legal obligation to put the clients’ best interest first. Not all advisors can say this. But all of the advisors at Align Wealth Partners can.
Let’s dig a little deeper into the fiduciary standard. What is a fiduciary?
The Fiduciary Standard Versus the Suitability Standard
Two primary standards apply to financial advisors: The fiduciary standard and the suitability standard. Any single financial advisor will adhere to one or the other. Each of these standards means different things for you, the investor.
Under a fiduciary standard, the advisor is expected to always act in accordance with your best interests, even if those actions turn out to be not in accordance with their own. It is the highest standard of care.
Fiduciaries act with loyalty and good faith and will give you a full disclosure of all important facts about your investments. Fiduciaries offer a special relationship of trust, confidence and responsibility, which can provide clients the peace of mind that their financial well-being is taken care of. Fiduciaries are regulated by the U.S. Securities and Exchange Commission.
We often hear from new clients that they question the advice they’re receiving from their current advisor. Fiduciaries will not use your assets for their own benefit or the benefit of any other clients. They will avoid conflicts of interest and disclose any potential for them.
Under a suitability standard, the financial advisor can make recommendations that are suitable for your financial situation and your goals. If a client’s goals are preservation of capital, for instance, they should recommend conservative investments such as bonds, not aggressive growth stocks or more risky investments such as options.
Financial advisors who follow a suitability standard are regulated by the Financial Industry Regulatory Authority (FINRA).
Comparing the Two
Potential clients are sometimes perplexed about these differences. And here’s why: Most Americans expect financial advisors to put the client’s interest first, as if it’s a uniform requirement for anyone giving financial advice. But it’s not. And this assumption can be dangerous. Only fiduciaries are legally bound to do so.
The biggest difference between the two standards means that advisors who follow the suitability standard can give financial advice that may result in bigger commissions for themselves. A broker affiliated with an investment firm, for example, may recommend the purchase of stock that results in higher commissions than another, similar stock, as long as the investment overall is suitable.
A fiduciary, on the other hand, could not recommend the purchase of a stock with a higher commission than another similar stock, because placing your financial interest first would require that any trading structure advantage be given to you. A fiduciary would be likely to trade with the lowest commission possible, all other factors being equal.
The differences are also reflected in the more constant nature of a fiduciary relationship. Because fiduciaries have a duty of care toward their clients, they are expected to know their clients’ financial situation more thoroughly and to continually monitor it.
A fiduciary, for example, should know how a life change, such as the sale of a business or a marriage, affects your finances. The fiduciary duty should prompt the advisor to ask if you have had any life changes over the course of the past year that has, or could in the future, change your financial situation or plans. A number of events, after all, could do this, ranging from the birth of children and planning for their education to receiving a bequest from a relative.
A financial advisor acting under the suitability standard isn’t obligated to know any of this, or to review your financial situation in any way other than determining the suitability.
The Compensation Structure
Fiduciary advisors and advisors using the suitability standard use a different compensation structure as well.
Fiduciaries can be paid via advisory fees or a combination of fees and commissions, but not by commission only. Fee-only advisors may charge at a flat rate, a rate per hour, fees based on services or fees based on Assets Under Management, usually as a percentage.
Suitability standard advisors, such as brokers, may be paid fees only, commissions only or a combination of fees and commissions.
Potential Conflicts of Interest
Advisors who are only compensated with fees have less potential to have a conflict of interest with any investments they advise, because they are not getting commissions.
Advisors compensated only by commissions, however, may have a conflict of interest, because their compensation is not divorced from their recommendations.
For example, if you were to receive a higher commission from particular stocks or receive higher fees for certain products, such as insurance or annuities, you may be more inclined to recommend those products.
That’s not to say that advisors working on a commission-only or commission-and-fee basis will necessarily act against their clients’ interest in order to receive higher fees and commissions for themselves. Many will keep their clients’ best interest in mind. However, a fiduciary has a legal obligation to do so.
How to Tell if a Financial Advisor is a Fiduciary
How can you tell if a financial advisor is a fiduciary? The best way is to ask! (And get the answer in writing.)
Many financial advisors will indicate their fiduciary status on their materials, such as websites, brochures and business cards. But some may not.
Don’t get fooled by titles. Titles don’t indicate whether an advisor follows a fiduciary standard or not. Titles such as financial advisor, wealth management advisor, asset manager and so on shouldn’t be used as a guide.
It’s wise to interview financial advisors when first getting started. During that period (or before), ask if the advisors you’re interested in are fiduciaries and follow a fiduciary standard.