What is Fiduciary Duty and How Does It Impact Financial Advisors?
Fiduciary duty refers to the responsibility of professionals such as financial advisors to prioritize the best interest of their clients in their work. Laws in countries worldwide mandate certain professionals to abide by their fiduciary duties while doing business and place their clients’ interests above their own. To find out whether the financial advisor that you may be looking to hire is a fiduciary or not, you can ask for their credentials. Hiring a fiduciary financial advisor is a wise decision since fiduciaries are legally obligated to serve their clients’ best interests, be transparent, minimize instances of conflicts, and act in good faith towards their clients.
Who is a fiduciary?
In simple words, a fiduciary is a person or an organization that manages a client’s finances and assets on their behalf. In a fiduciary relationship, the party that looks after the money and property of another individual for the latter’s benefit is called a fiduciary. The party who receives the benefits from the fiduciary’s actions is named the beneficiary.
A fiduciary relationship is, in essence, a relationship of trust between two parties. A fiduciary is someone who is legally and ethically expected to work in the best interest of their clients. The law enforces a fiduciary duty, and it is supposed to reduce conflicts of interest and make a professional such as a financial advisor more trustworthy in the clients’ eyes. A fiduciary duty is an essential responsibility for the fiduciary. Should they fail to fulfill their fiduciary duty, the principal or beneficiary could suffer severe damages.
What comprises fiduciary duty?
Two primary duties form a part of the broad term of fiduciary duty; these are the duty of loyalty and duty of care. Let us look at what these duties comprise.
1. Duty of Care:
This duty states that a fiduciary is required to make informed decisions after critically reviewing all the available information. For instance, financial advisors should make money-related decisions after extracting and examining information regarding your financial position, financial goals, level of risk tolerance, and more. They must make financial plans and recommendations that suit an individual client’s needs and preferences. On the other hand, company directors might source their knowledge from industry experts and keep detailed records to come up with practices that would be best for the growth and development of the company.
2. Duty of Loyalty:
Under this duty, a fiduciary should not have any undisclosed personal or economic interest that is not in line with the client’s interests. They are prevented from pursuing their private interest, which may harm the wishes of the client. Adhering to the duty of loyalty requires fiduciaries to disclose any plans or recommendations that fetch them a commission. Also, fiduciaries are bound by law to ensure that there is no conflict of interest brought about in the line of work when they work with different clients.
Being a fiduciary in different industries might demand additional duties besides those mentioned above. Fiduciaries who are a part of the financial services industry, such as analysts and corporate financial heads, are obliged to at the very least fulfill the duty of loyalty and care.
What is the fiduciary standard of duty?
The terms financial advisor and fiduciary differ in terms of their meaning. While a financial advisor refers to a job description that may or may not include fiduciary advisors, a fiduciary professional upholds the fiduciary standard of duty. Fiduciaries have to primarily put the interest of their clients before their own, even if it clashes with their personal goals. Fiduciaries include certified financial advisors and comprise attorneys, guardians, and several other professionals.
Financial fiduciaries work towards providing suitable financial solutions at the lowest possible cost to their clients. One should, however, keep in mind that not all financial advisors are fiduciaries. Individuals can give out financial advice by calling themselves financial advisors legally. Hence, you must know whether your financial advisor is a fiduciary or trustworthy.
[See: What is a Fiduciary Advisor: Roles and Benefits]
Generally, fiduciary advisors work for Registered Investment Advisor firms. You will also find fiduciary advisors among Certified Financial Planners or CFPs. Advisors hired under brokerages are usually not fiduciaries. Nevertheless, they are also held to a suitability standard, which is a relatively lesser standard level than fiduciary. Abiding by fiduciary requirements would require the advisor to maintain the highest quality of standards for client service in terms of providing advice and financial planning.
How much do fiduciary financial advisors charge?
Financial advisors commonly charge a commission, a flat fee, or a combination of both according to the various services they may offer. While planning to appoint a new financial advisor, it is essential to check whether they are fiduciary and how they charge fees. This information will help you anticipate any conflicts of interest. Fiduciary or not, a financial advisor usually charges the client in the following ways:
1. Commission only
Some financial advisors rely on commissions for their income. They make money either through selling investments or by recommending and selling certain financial products to their clients. Commission-only financial advisors are widely hired under brokers and are held only to the suitability standard. Ensure that a commission-only financial advisor is a fiduciary, or at least make sure you properly review the products being sold and what their commission entails before hiring them for consultation.
2. Fee-Only
Similar to commission-only financial advisors, fee-only financial advisors earn their money solely based on the fees they charge their clients. The fees might be calculated as a percentage of the total wealth managed on your behalf, set as a fixed amount, or charged on an hourly basis. These advisors do not earn any commission or additional income when you buy or sell securities. For this reason, fee-only financial advisors rarely have conflicts of interest with their clients since their earnings are not dependent on the marketing and selling of financial products. Still, they are required to disclose any conflicts that they may have with their client. The majority of the fee-based financial advisors are fiduciaries.
3. Combination of both
It can be said that the fee-based financial advisors combine aspects of both the aforementioned methods of charging fees by financial advisors. Fee-based financial advisors may earn their income through fees, commissions, or both. Since these advisors earn extra through referral fees as well, there is a chance that they might not be fiduciaries and may also have the potential of conflict of interest with the client. Hence, it is advisable to verify their credentials as fiduciaries. However, keep in mind that if an advisor is earning commission, the product they recommend might not necessarily be in conflict with your preferences. Certain beneficial products such as life insurance might be recommended and sold on a commission-based model.
You will encounter a lot of financial professionals pushing you to opt for a fee-based financial advisor. A fee-based financial advisor as opposed to their commission-based counterparts has no motive to ignore your financial needs for their own personal gains. A fee-based advisor’s generation of income is directly related to their customers’ growth. It is essential for them to maintain good customer relations to network and have long-lasting customer relations. On the other hand, commission-based advisors would be able to make money without giving any consideration to the fact that the customer may or may not return to them for advice.
[See: What Are The Costs Involved In Hiring A Financial Advisor?]
Steps to find a fiduciary financial advisor
You can follow the steps mentioned below to choose a fiduciary financial advisor:
1. Be aware of your financial goals:
It is better to determine your financial goals and establish them before searching for a good financial advisor. You may have specific short-term and long-term goals like retirement plans, a plan to fund your children’s education, or a wish to buy a house in the next five to ten years. Some financial advisors have different areas of specialization, which is why you may want to find an advisor whose experience and knowledge match your financial targets and background.
2. Research suitable financial advisors for your needs:
Word of mouth can prove to be of great help when searching for a financial advisor. Hearing about their experiences and feedback can help you narrow down on a financial advisor that suits your needs. You can also take the help of various online directories of financial advisors to help find one that meets your requirements.
3. Go through the potential advisors’ Form ADV:
Investment firms must file the Uniform Application for Investment Advisor Registration (Form ADV) with the SEC on an annual basis. This form is available for review by the public on the SEC website. The form gives the reader a summary of a firm’s credentials, services, fees, credentials, and disciplinary history.
4. Fix a meeting with a potential financial advisor:
Face-to-face communication with your prospective advisor will help you figure out their investing philosophy. It will also enable your advisor to better understand your financial background and goals. Good communication with your financial advisor is critical to successfully maintain and grow your wealth and accomplish your financial targets over time. You should make sure to ask your advisor about their streams of income and if they are fiduciary during your first meeting with them.
To summarize
There are several kinds of financial advisors that you may consider hiring for your financial needs such as investment advisors, financial planners, wealth managers, certified financial planners, robo-advisors, and more. However, not all of them have a legal obligation to serve your best interests at all times. Fiduciaries, on the other hand, are financial advisors such who have a fiduciary duty to put your interests before their own. They are duty-bound to act in your best interests, failing which you can pursue legal action against and sue them for breach of fiduciary duty. Hence, it is highly recommended that you consider hiring a fiduciary as a financial advisor as they might be best suited to serve your interests above their own while also meeting your financial requirements.
Are you looking for a fiduciary financial advisor? Use Paladin Registry’s free advisor match tool to match with qualified financial fiduciaries who may be able to help you with your unique financial requirements. Answer a few basic questions about yourself, and the match service will help connect you with 1-3 financial advisors suited to your financial needs and goals.
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