Consumer Watchdog: Understanding Fiduciary Duty

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Financial advisors should be keeping their clients best interests in mind at all times – but decades of Ponzi schemes like the Bernie Madoff scandal and the collapse of major financial institutions make Americans wary of who to trust.

Many consumers who work with financial advisors or stockbrokers have heard the term fiduciary duty. This refers to the legal obligation of advisors to act in your best interest by picking products suited to your financial goals. These products should charge the lowest fees. Financial advisors often charge a flat fee or receive a small percentage cut of the assets you give them to manage. A stockbroker (commonly referred to as broker) works under a different set of rules.

Brokers work for large investment firms and instead of working under a fiduciary obligation; they adhere to suitability standard. This means their advice to clients only needs to be suitable, not the best match. Naturally, this will encourage brokers to sell the products with higher kickbacks instead of the lowest fees for clients.

It seems it should be simply enough to tell the difference. Financial advisors are required to act under fiduciary standard. Brokers the suitability standard. Just go with the financial advisor, right?

Wrong.

Major brokerages often call their brokers financial advisors, but the brokers can still operate under suitability standard.

There have been legal battles over the past two decades about whether brokerages should be legally allowed to call a broker a financial advisor. Under current regulations, it is legal as long as the brokers calling themselves advisors met SEC disclosure standards.

Proposed Changes

After previous attempts, the government is once again trying to set stricter regulations for financial advisors.

The Department of Labor is working on amending the definition of fiduciary under the Employee Retirement Income Security Act.

This would require retirement advisors to put a client’s best interest ahead of their own financial gain. Ideally, the proposal would prevent advisors from championing retirement fund rollovers out of low-cost funds into higher-cost ones as well as suggesting saving into funds with higher fees and lower returns.

The proposal has not been publicly released, but a White House press release does highlight some of the issues it perceives with the current fiduciary standards.

The Opposition

Protestors to the proposed changes point to a lack of incentive for financial advisors to take to low- and middle-income clients because these accounts will be less lucrative than those of wealthier Americans.

How to Protect Yourself 

Whether or not this proposal ultimately becomes the new fiduciary standard, you need to know how to find the best financial advisor.

1) What do you want?

Decide what you want out of a relationship with a financial advisor before you seek one out. Are you in the start of your career and looking for basic investing advice? Do you need wealth management? Are you preparing an estate or just trying to figure out how you can comfortably retire?

2) Does your financial planner have the right credentials?

Any person off the street can claim the title of financial planner, so it’s up to you to ensure yours has the right credentials. There are a wide variety of certifications including: Certified Financial Planner, Chartered Financial Analyst, Chartered Financial Consultant, Personal Financial Specialist and Registered Investment Advisors. Check that your financial advisor is qualified and specializes in what you need him or her to do for you.

3) Where is the money coming from?

Find out upfront if you’re paying based on commissions or a fee structure. A commissions-based relationship will likely lead to incentives for your advisor to steer you towards something that may be suitable but not the best financial match.

4) Is your advisor a fiduciary?

Avoid the confusion by just asking. Plus, working with a fiduciary means your advisor is required to disclose his or her fees, compensation and any potential conflicts of interest.

5) Can I see a sample plan?

You should ensure your styles and expectations match before you sign up to work with someone. Do you want a massive document detailing every aspect of your financial life or would you prefer a short overview (perhaps with some pretty graphs)? Ask a potential financial advisor for a sample before signing on the dotted line.

6) Where’s the report card?

You wouldn’t hire a babysitter to watch your kids without checking references. Why would you hire someone to watch your money without doing the same? Check an advisor’s past performance, look for any legal disputes and try to speak with current (or former) clients.

7) Do your styles and priorities align?

If you’re a conservative investor, you won’t want to work with someone who is extremely bullish. Find an advisor you feel will tailor at portfolio to your wants and needs. Ask your advisor for his or her investment approach to make sure they line up with yours.

And lastly, be sure it’s easy to communicate with your financial advisor. Set expectations early one for how frequently you’ll be in touch and whether or not you’ll be working directly with the advisor or a member of a larger team.

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