Why a Fiduciary Duty Matters When Choosing a Financial Advisor

Earlier this week, we examined why financial advisors might do this crap.

Good financial advisors pursue certifications and take oaths to separate themselves from the pack.

How can you benefit from working with a fiduciary financial advisor, compared to working with financial advisors that aren’t fiduciaries?

Learn more in this guest post from David Rosenstrock, the Director and Founder of Wharton Wealth Planning, LLC.  David earned his MBA from the Wharton Business School and B.S. in economics from Cornell University. He is also a Certified Financial Planner™.  He lives in New York with his wife and their two very active children.

What is a Fiduciary?

Advisors who possess a fiduciary duty to their clients are required to put their clients’ best interests above their own at all times. Many people are surprised to find out that this obligation isn’t required of all advisors. In fact, most advisors aren’t required to act as a fiduciary in all their interactions with a client. Advisors who are not fiduciaries often follow the suitability standard, but that only requires that they give clients advice deemed “suitable” for their situations, thus it offers fewer protections/safeguards to clients.

Why Do Fiduciaries Matter?

Fiduciary advisors have two main duties while managing money which include a duty of care and a duty of loyalty.  Duty of care means fiduciaries are required to make informed business decisions by reviewing all of the available information about your financial life before making recommendations or plans.

A major benefit of working with fiduciaries is that they always look out for the client’s best interests and disclose any conflicts that may negatively affect the client (which relates to the duty of loyalty). This can have a profound impact on the decisions you and your financial advisor make in collaboration and what they might have you do to preserve or grow your wealth.

Fiduciary advisors are legally bound to not use a client’s assets for their own benefit. This relationship and standard of care serves to prevent situations where there are conflicts of interest. For example, a financial planner may encourage you to use certain investments because he or she could have a stake in them. Advisors may favor certain products because they can benefit from them. Fiduciary advisors have a duty to explain why they are making a decision and what you could gain or lose from it.

There are many well-regarded regional and national brand name storefronts that do not follow fiduciary standards and this may be in direct conflict with what is in the best interest of prospective clients.  Most financial advisors have to sell investments that are suitable for clients, but fiduciaries must act with a higher standard of care. As a result, fiduciary advisors are often less expensive because client accounts aren’t charged commissions. A fiduciary advisor is important if you plan to give an advisor discretionary control of your account, if you aren’t sure what you need, and if you want sound, objective advice. When seeking wealth-planning strategies, it is important to bear in mind that not every firm providing financial advice is a fiduciary advisor.

Some red flags that an advisor doesn’t always act as a fiduciary include a Series 7 license and a Series 63 or 66 license. If a financial advisor has a Series 7 license they are allowed to collect commissions from the sale of investments, which means they don’t always act in a fiduciary capacity. A Series 63 or 66 is another license that a financial advisor needs to collect commissions on product sales.

Different Types of Fiduciary Advisors

The term fiduciary is still not widely known and understood. One of the most important questions you can ask a financial advisor is, “Are you affiliated with a broker/dealer?” If they are, then they are not a true fiduciary because they are in a position to receive benefits, commissions, and kickbacks for selling you a certain product. True fiduciaries typically work for Registered Investment Advisory firms (RIA) in accordance with the Securities and Exchange Commission’s Investment Advisors Act of 1940. Some financial advisors work for a firm that is both an RIA firm and a broker/dealer firm. They may claim to be a fiduciary because they work for an RIA, but this does not mean that they act as a fiduciary 100% of the time.

One way you can be sure your financial advisor will act as a fiduciary is to work with a Certified Financial Planner, often referred to as a CFP®. Upon earning the Certified Financial Planner designation, CFPs acknowledge they will adhere to the CFP Board’s Code of Ethics and Standards of Conduct and act as a fiduciary when providing financial advice to their clients. This standard applies to those who are Certified Financial Planner (CFP®) certificants, and not anyone else who holds out as a financial advisor. Even more significantly, it only applies within the scope of financial planning. The CFP actually has to be providing what are called “material elements of financial planning” to be deemed a CFP fiduciary.

The CFP fiduciary standards are much broader in scope in terms of what the fiduciary duty actually covers. You have to be doing financial planning, but once you are, it applies to all financial planning activities, including subsequent recommendations. Thus, arguably, a CFP fiduciary is actually the broadest fiduciary rule in scope, because it applies to your retirement advice, tax advice, insurance advice, investment advice, and everything else under that is categorized as financial planning.

The basic concept around the term fee-only fiduciary, which is another category of fiduciary advisor, is that this type of advisor only can receive compensation directly from the client for services provided.  In other words, fee-only advisors do not receive sales-related compensation from their employer or third parties (like fund companies). In this instance, fees can take the form of a flat rate, an hourly fee (or project-based fee), a subscription fee, or a percentage of assets under management.  Fee-only advisors can work with clients on a one-time financial planning basis or on an ongoing basis, depending on what suits the circumstances best.

In order to reduce conflicts of interest, many fiduciary financial advisors may choose to not offer certain products directly, and instead, recommend their clients purchase products elsewhere. In other instances, when fiduciary advisors offer their clients certain products or services, they will disclose any conflicts of interest regarding their recommendation, place their clients’ interests ahead of their own, and most importantly, act without regard to their financial interests.

Robo-Advisors as Fiduciaries

A robo-advisor is a type of brokerage account that automates the process of investing. Most robo-advisors charge lower fees than conventional financial advisors because they invest your money in pre-formulated ‘model’ portfolios made primarily of specially chosen, low-fee exchange-traded funds (ETFs). Like conventional human financial advisors, robo-advisors are regulated by the Securities and Exchange Commission (SEC) as Registered Investment Advisors (RIAs), meaning they have a fiduciary responsibility to look out for your best interests when it comes to investment choices.

Is the Fiduciary Standard Enough?

Critics say that the fiduciary standard has failed to keep pace with the way that investment advice has evolved, allowing many advisors to escape fiduciary responsibilities. Some believe the fiduciary standard is not strong enough and that fiduciaries should be held to higher scrutiny.  It’s increasingly difficult for consumers to differentiate between fiduciary advisors and advisors. It is also worth noting that just because an advisor is a fiduciary that a prospective client should still interview them carefully and judge on educational background, commitment level, certifications earned, areas of focus and expertise, and how the advisor engages. A clear fiduciary standard, equally applied to all financial professionals who provide retirement investment advice, is becoming a necessity to protect investors in today’s rapidly evolving marketplace.

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Virtual Fiduciary Advisors

A fiduciary financial advisor can uphold his or her fiduciary duties if the advisor is working virtually (online or Zoom), in addition to in person with you. In most instances, storing, managing, and sharing files will be an extremely important part of the virtual financial planning process and analysis. The advisor should use secure video conferencing and financial technology, including file sharing, to collaborate with clients and protect their financial information. To ensure private content is kept safe, documents shared with a virtual financial advisor can use a combination of security measures including data encryption, authentication processes, and password protection.

Working with a virtual advisor can have several advantages including saving you time and increasing convenience. Virtual or digital financial planning also can allow clients to find and select the best fiduciary financial advisor for their specific needs and does not limit clients to working with someone based solely on shared location.

For more information, contact David Rosenstrock, david@whartonwealthplanning.com