Financial Advisor Ethics: What You Need to Know
Hiring a financial advisor can be one of the smartest moves you can make. Having a trusted advisor can mean the difference between achieving your goals and having a future full of financial stress. But…it is extremely important to choose your advisor carefully.
It would be nice to think that all financial advisors are required to act ethically—that is, to always act in your best interest, not theirs. But did you know that the law doesn’t require all advisors to do that? Read on to find out why, and learn what to do to avoid advisors who may not be required to do the best for you they can.
A Very Low Bar
Hiring a financial advisor is quite different than hiring any other professional. You can’t just look around and pick one you like best. For one thing, there’s no state organization (like the state bar for lawyers) that requires a person to earn the status. Believe it or not, there’s no mandatory education, experience or exhaustive testing requirements. Instead, really anyone can use the title “financial advisor”.
Real Advice or Sales?
Compounding the problem, there are two different legal standards to which advisors are held.
The first one is the fiduciary standard. Advisors who fall under this category are legally required to put your interests first. These advisors must act as a “true” advisor. This person needs to learn about you, your goals, and your responsibilities and then help you put a plan in place to achieve the best outcome. If they don’t do this, you have legal recourse. These types of advisors are known as “Fiduciaries”.
The other legal standard is called the suitability standard. A financial advisor who falls under this category is not legally required to act in your best interest. Instead, they are simply required to make “suitable” recommendations for you. So if they learn about you and your goals, they can recommend a product that pays them a higher commission, as long as it was generally suitable. You end up spending far more than you needed to because of the commission, but they didn’t do anything wrong. Their duty of loyalty actually lies with the company they work for, not to you. These people are really product salespeople.
Of course, there are many honest and knowledgeable salespeople out there, but the companies they work for will want (and often require them) them to sell certain products. This creates an ethical problem—these advisors may end up giving you “conflicted advice”.
Does it Really Make a Difference?
Does hiring one type over the other really make much of a difference? A White House Council of Economic Advisers (CEA) report states that “conflicted advice” about investments is estimated to cost Americans $17 billion per year. That’s right – that’s per year.
As you can see, you are far better off to avoid these types and instead look for a fiduciary only.
Finding the True Advisors
So, the true advisors are fiduciaries. But determining who is a fiduciary and who is not can be quite difficult. Sadly, there are many creative titles out there to keep everyone confused. Making it worse, even some fiduciaries may be “dual registered” so they potentially can also act as salespersons part of the time.
Fortunately, there’s a few steps you can take to cut through the confusion.
Certification Agencies
There are some certification agencies that require members to adhere to a code of ethics. The code of ethics will usually require them to put your interests first. And, these certifications require significant study and testing to achieve. Good certifications include CFA®, CPA®, and CFP®. But, there are some designations that advisors can get that simply make them look more knowledgeable than they really are. These may just require payment of a fee or taking one course. So it is vital to know the difference.
There is a free online resource where you can check the quality of advisor certifications and designations: www.paladinregistry.com/research/credentials-financial-certifications.
Independent Advisor Data Companies
Another option is to take advantage of independent third-party sources that collect information for you to help you figure out who is a true advisor.
One such option is Brightscope. Brightscope aggregates a wide variety of fiduciary and non-fiduciary advisors, so you need to do some screening, but does provide a lot of public information in a standardized format. You can quickly find out if the advisors you are evaluating have a clean compliance record, which is another valid way to judge ethical behavior.
Independent Advisor Rating Companies
Other free services provide advisor ratings and screening. Paladin Registry, free to consumers, vets advisors and only accepts those who match specific requirements. One requirement is that all advisors accepted must be fiduciaries. Paladin also checks credentials, requires minimum years of experience and checks out an advisor’s compliance record before accepting them into the registry. Paladin offers a free matching service to match you up to local independent fiduciary advisors in your area that meet their standards.
Don’t Ever Stop Checking
All of these resources are a good start. But whatever you do, take the time to verify before hiring. And look around very carefully. Keep in mind you are looking for the best advisor, not someone you like the most. Don’t fall for a slick sales pitch, as the most friendly or charismatic advisor may not be the best or safest option for you. Instead, you want someone who will be your trusted advisor—and always put your interests first.
Then once you find that person, don’t just relax and put it on auto-pilot. It’s your money and it’s vital that you stay on top of it. As Ronald Reagan said, “Trust, but verify”. Stay involved, read your statements when they arrive, and question anything that doesn’t look right. A good advisor welcomes an interested investor and understands that a smart person looks after their money at all times.
Jeanne Klimowski is Founder of Wavelength Financial Content Inc., a provider of employee financial wellness programs and digital content for financial advisors.
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