by Jack Waymire
Choosing a financial advisor is one of the most important decisions you will ever make – what happens with your investments can literally alter the course of your lifestyle, and your life. When selecting a financial professional, many consumers assume the advisor will automatically act in the client’s best interest. Unfortunately, that isn’t always the case. In many instances, financial “advisors” are incentivized to sell various products to their clients, regardless of whether those products serve their clients’ best interests.
Table Of Content
- Sets of standards for Advisors
- What is a Fiduciary?
- Issues while finding a right financial advisor
- RIAs are Legal Fiduciaries
- How to determine if an Advisor is a Fiduciary
- How are Fiduciary Advisors compensated?
- Do Fiduciary Advisors accept any other forms of compensation?
Before you move forward in working with a financial advisor, you need to know under which set of “rules” he or she is working. Under financial laws and regulations, there are actually two different standards of consumer protection.
Two Sets of Standards for Advisors
One set of rules is for financial advisors who offer various insurance and investment products. These “salespeople” are essentially obligated to their employer – not to their clients. The other is for professionals who are registered as investment advisors with the Securities and Exchange Commission (SEC) or comparable state regulators.
In the case of the latter, a Registered Investment Advisor (RIA) does not sell specific products to their clients, but instead offers financial advice and solutions. In doing so, he or she must act in a fiduciary capacity, placing the clients’ interests above all else. In fact, as fiduciaries, it is their legal obligation to do so.
What is a Fiduciary?
Throughout history, the status of fiduciary has been applied to those who, because of their specialized knowledge and the confidential nature of the service provided, are entrusted with certain powers or authority by individuals who are then vulnerable to the possible overreach of the specialist. This special status has been codified in laws and regulations to provide individuals with transparency into the actions of the specialist, including requirements for complete disclosure of activities and compensation.
Over time, the courts have obligated fiduciaries to two specific requirements: The duty of loyalty; and the duty of care. This legally entitles their clients to expect the highest level of integrity and honesty in their dealings. The SEC narrowed its view of the fiduciary standard to include even more specific standards, including:
- To manage portfolios in the best interest of clients
- To provide clients with undivided loyalty
- To make full and fair disclosure of all material conflicts of interest
- To seek the best execution for client transactions
- To ensure that investment advice is suitable for clients’ objectives, needs and circumstances
- To refrain from effecting personal securities transactions inconsistent with client interests
The benefits of working with a fiduciary are clear: When an advisor puts your interests first, he or she is making recommendations that are best suited for your situation. Fiduciaries invest your money the way they would if it was their money. All decisions are made with the best intentions and for reasons that are important to you. They don’t sell. They don’t push. They act in your best interests. They have to.
The Real Issue
When it comes to finding the right financial advisor, here’s the real issue:
The investor wants to accumulate assets to achieve financial goals, for example, accumulate assets for retirement. The advisor wants to make a good living. Investor goals and advisor goals are different. For example, the advisor makes a better living when he maximizes the revenue/income he produces from the investor’s assets.
So, which need prevails?
If the advisor is a fiduciary, then the investors’ needs (achieve financial goals) have to come first. If the advisor is not a fiduciary, then he or she is supposed to make suitable recommendations, but investor needs do not have to come first.
FYI, suitable is a very vague standard that is very difficult to enforce, which is just the way Wall Street wants it.
This is a big issue when people select financial advisors, and it can be very confusing, in particular when people are not sure what fiduciary means, how it impacts them and how to determine who is a fiduciary.
RIAs are Legal Fiduciaries
The only financial advisors who are legally required to apply the fiduciary standard in their dealings with clients are those registered with the SEC as Registered Investment Advisors (RIAs) or Investment Advisor Representatives (IARs). RIAs operate as independent firms and IARs are financial advisors who operate under a RIA. They carry either a Series 65 or Series 66 license.
By definition, fee-only RIAs are the only truly independent source of unbiased advice. They are compensated directly by their clients, so they answer only to them. They are independent of shareholder control, investment banking influence, closed architecture product platforms and revenue-sharing arrangements, plus any other element that might preclude them from offering unbiased, conflict-free advice. As such, they are the only advisory model that can hold claim to a strict adherence to the fiduciary standard of care.
All Other Advisors Are Not
Any other type of financial advisor is not legally bound to act in a fiduciary capacity. In fact, they are prevented from doing so by the firms that employ them. They are held to a much lower standard that only requires that the recommendations they make to clients be suitable for their situation, even if it may not be in their best interests.
Although they may go by many different titles – “financial advisor,” “financial consultant,” “wealth manager” – they are registered representatives licensed through the Financial Industry Regulatory Authority (FINRA). They carry a Series 6 or a Series 7 license, which allows them to sell investment products. (See our article, “How to Distinguish Between Fee-Based and Commission-Based Advisors” for more information on how advisors are compensated.)
What all these other types of advisors have in common is that they are all captive representatives, employed by their companies to sell only the products that are available on their product platform. They are also compensated by their companies in the form of commissions and production bonuses. The more products they sell the more commissions they earn and the higher their production bonuses, which puts them at odds with a client’s best interests.
How to Determine if an Advisor is a Fiduciary
With the answers to a few questions and some evidence to support them, you can know fairly quickly whether an advisor is a fiduciary. When you first speak with an advisor, the very first questions you should ask are as follows:
Are you a fiduciary?
The answer is either a “yes’” or a “no.” If the advisor answers “yes,” ask to see a copy of his Form ADV. Form ADV is a uniform form used by investment advisors to register with the SEC and state securities agencies. The form is divided into two parts – ADV Part I and ADV Part II – in which the advisor must disclose everything about his operation as a financial advisor, including forms of compensation and possible conflicts of interest. (For more on how to read Form ADV, see our article, “What to Look for When Researching a Financial Advisor.”)
If the advisor won’t or can’t provide you with a copy of his Form ADV, he is probably not a fiduciary RIA. You can also see a copy of an advisor’s Form ADV on the SEC’s Investment Advisor Public Disclosure website.
How are you compensated?
True fiduciary advisors are only compensated with fees paid directly by their clients. The fee is typically a percentage of the amount invested with the advisor, typically around 1 percent. They might also charge a flat fee for advice and some charge an hourly fee. You can verify their compensation in their Form ADV.
Do you accept any other forms of compensation?
A true fiduciary advisor does not accept any other forms of compensation, especially from third-party providers. If they do, it must be disclosed in their Form ADV. It is important to note that some RIAs, often referred to as hybrid-RIAs, also offer investment products for a commission. Not only must they disclose their compensation for offering these products, they must also disclose they are not operating in the capacity of a fiduciary when they do so.
Hire a financial advisor who will absolutely put your interests above his or her own, you must work with a fiduciary advisor. To ensure you are working with a fiduciary, do not ask for anything less than the answers to these questions and the documentation to support them.
Jack Waymire worked in the financial services industry for 28 years before he left to found the Paladin Registry (www.PaladinRegistry.com) in 2004. This investor education website was based on the Principles in Jack’s first book: “Who’s Watching Your Money? The 17 Paladin Principles for Selecting a Financial Advisor.”
The Registry also has a free service that matches investors to advisors who meet Paladin’s minimum requirements for competence and trustworthiness.
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