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A fiduciary financial advisor is a financial advisor who is legally and ethically bound to act in their clients’ best interests at all times. What’s surprising to many, however, is that not all financial advisors are fiduciaries, meaning some are legally allowed to make a profit at their clients’ expense.
Here’s what you need to know about the differences between fiduciaries and non-fiduciaries, how recent regulations impact them and how the financial advisor you choose may affect your investments.
Generally speaking, financial advisors bound by fiduciary duty must put their clients’ best interests before their own.
Currently, all financial advisors registered with the Securities and Exchange Commission (SEC) — known as Registered Investment Advisors (RIAs) — are bound by fiduciary duty. However, not all financial advisors are RIAs, and therefore some don’t adhere to the fiduciary standard. That means that some advisors are legally able to put their own interests ahead of their clients’ and recommend investments that make them a profit at their clients’ expense.
In recent years, there have been attempts to bring more conformity to the industry in terms of how and to whom fiduciary duty applies.
Department of Labor’s fiduciary rule: In 2016, under President Barack Obama, the Department of Labor’s fiduciary rule went into effect. It required all financial services professionals providing advice on retirement accounts, such as 401(k) plans and individual retirement accounts (IRAs), to follow fiduciary standards. In 2018, however, the rule was struck down by a federal court after a change in the administration.
Regulation Best Interest: After that, the SEC took matters into its own hands and created a new rule, called Regulation Best Interest (Reg BI), which took effect in June 2020. It differentiates between RIAs, who are financial advisors that only provide advice, and broker-dealers, who provide advice and sell products and investments from which they may earn a profit.
Previously, only RIAs had to meet fiduciary standards, while broker-dealers were required only to follow the less-stringent suitability standard (see more below). The new rule doesn’t go as far as to require broker-dealers to follow the fiduciary standard, but it does require them to make recommendations in their clients’ best interests and sets out requirements that are more stringent than the suitability standard.
The fiduciary standard
The suitability standard
As of June 2020, however, broker-dealers must also act in their clients’ best interest. Previously, broker-dealers could recommend products that would earn them the highest commission, even if they weren’t necessarily the best ones for their clients. Now, they must act in their clients’ best interest, but only at the time they make a transaction recommendation. Those who abide by the fiduciary standard must act in their clients’ best interest at all times, including while providing ongoing advice and monitoring client accounts.
The duty of a fiduciary financial advisor is to hold their clients’ trust by making decisions in their clients’ best interests.
The importance of fiduciary duty lies in the confidence it provides a client so they don’t have to second-guess the motive for the advice they’re given. They can rest assured that they are being given the best, most objective advice that the advisor has to offer, rather than wonder if they’re being steered in a direction because their advisor stands to make a larger commission.
Think of it like going into a shoe store to purchase a pair of shoes. Under fiduciary duty, the salesperson would advise you to purchase the pair of shoes that fits you best and looks best on your feet. Without fiduciary duty, the salesperson might try to convince you that the too-small, odd-looking pair is amazing, because it’s a more expensive shoe that will mean a bigger commission for them. Of course, there’s no fiduciary rule when it comes to shoe sales, but it illustrates the point as to the difference between working with a fiduciary financial advisor as opposed to a non-fiduciary.
As of now in the financial industry, only RIAs are required by law to meet the fiduciary standard. Financial advisors aren’t, however, the only professionals who are bound to fiduciary duty by law.
Other professions that involve trust with their clients, such as real estate agents, physicians and attorneys, are also fiduciaries. While the precise rules vary by profession, in general, they all require that the professional act in the best interest of their clients.
A breach of fiduciary duty involves an action in which the fiduciary puts their own interests before a client’s. In the case of a financial advisor, a breach of fiduciary duty would involve the advisor making recommendations that earn them a profit at a client’s expense. Examples of breach of fiduciary duty may include actions like:
If a client believes there has been a breach of fiduciary duty, they can sue the advisor for damages, including trading losses and well-managed account losses.
According to the National Association of Personal Financial Advisors (NAPFA), non-fiduciary advisors cost investors up to $17 billion a year. That’s a lot of money that could have been in the pockets of individual investors.
The fees and services that fiduciaries and non-fiduciaries offer may be similar, but it’s the missed opportunities that can result in this loss to investors. For example, a non-fiduciary may advise you to purchase a “good” product because they will receive a larger commission or another incentive for selling that product. However, there may be a better product that would have benefited you more financially that they didn’t recommend because it didn’t offer an incentive for them.
That doesn’t mean that all non-fiduciaries are going to provide bad financial advice, but choosing a fiduciary provides extra assurance that your financial best interest is the advisor’s biggest priority.
There are a number of factors to consider when choosing a financial advisor, but determining if they’re a fiduciary is one of the most important. While Regulation Best Interest provides more assurance that all advisors are working in your best interest, the fiduciary rule is the most-stringent standard, and fiduciaries provide the most reassurance that you’re getting your best advice possible.
There are a number of ways to find an individual or firm that abides by fiduciary duty:
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.