How Fiduciary Duty Impacts Financial Advisors
Fiduciary duty is the requirement that certain professionals, like lawyers or financial advisors, work in the best financial interest of their clients. U.S. law dictates that members of certain professions who are doing business for certain clients be bound by fiduciary duty. Let’s take a closer look at fiduciary duty, what a fiduciary is, which professions commonly have fiduciary responsibilities and which types of financial advisors are actually fiduciaries.
What Is a Fiduciary?
A fiduciary is someone who manages property or money on behalf of someone else. When you become a fiduciary, the law requires you to manage the person’s assets for their benefit—and not your own.
In a fiduciary relationship, the person who must prioritize their clients’ interests over their own is called the fiduciary. The person receiving services or assistance is called the beneficiary or principal.
A fiduciary relationship can exist between friends or family members. For example, you might manage a friend’s expenses if they become ill and undergo medical treatment. But more commonly, you’ll deal with a fiduciary when working with certain types of professionals, such as lawyers and financial advisors. Directors of corporations also have a fiduciary responsibility to act in the best interest of their company and shareholders.
Fiduciary duty is a serious obligation. If a fiduciary doesn’t fulfill their duties, called a breach of fiduciary duty, the beneficiary could be entitled to damages.
How Fiduciary Duty Works
In acting in a beneficiary’s best interest, fiduciaries have two main duties: duty of care and duty of loyalty. Fiduciaries may have different or additional requirements, depending on their industry. Those in the financial services industry, such as registered investment advisors (RIAs), financial advisors and directors of corporations generally must abide by at least duty of care and duty of loyalty.
- Duty of Care. Under the duty of care, fiduciaries must make informed business decisions after reviewing available information with a critical eye. Financial advisors might fulfill this by analyzing comprehensive information about your financial life before making recommendations or plans. Directors of companies, on the other hand, might consult industry experts and maintain detailed records and best practices for the company.
- Duty of Loyalty. To abide by the duty of loyalty, fiduciaries must not have any undisclosed economic or personal conflict of interest. They cannot use their position to further their private interests. Fiduciary financial advisors might adhere to the duty of loyalty by disclosing any recommendations they’ll receive a commission on.
Positions with Fiduciary Duty
The responsibilities of a fiduciary remain consistent, even across different types of professional relationships. Common professions or positions that require fiduciary duties include:
Trustee of a Trust
When you want property, money or other valuables to transfer to someone after you pass away, you can place them into a trust, a type of legal entity. The trustee, the person in charge of the trust, has a fiduciary duty to manage the trust and its assets to benefit the person who will one day inherit it. The trustee, for example, cannot use the trust’s assets for themselves, or they’ll be subject to legal action.
When you pass away, the person who manages your estate and handles your affairs is your estate executor. Not only are they responsible for handling any taxes and last financial issues, but they also have a fiduciary responsibility to your heirs and next of kin. They must distribute the estate according to your wishes and cannot favor themselves when passing out your assets.
If you hire a lawyer to represent you, they have a fiduciary duty to you. They must disclose any conflicts of interest and must focus on your best interests. This responsibility is especially important when working with a lawyer to develop your estate planning documents, such as your will, living revocable trusts and powers of attorney. Fiduciary duty applies to all lawyers, from solo attorneys representing individuals in personal injury lawsuits to corporate lawyers who represent huge Fortune 500 companies.
Directors of Corporations
Those who are in charge of companies have a fiduciary duty to run them in ways that put the company’s (and shareholders’) financial interests above theirs. Directors of corporations must critically examine all information related to their companies and disclose any personal interests that might interfere with their abilities to run them.
Real Estate Agents
Real estate agents are also generally considered fiduciaries, meaning they owe their clients full disclosure of any conflicts of interest or concerns that affect the value of the property. Real estate agents can represent both the buyer and the seller in a transaction and maintain their fiduciary duty as long as they inform both clients and have them sign an agreement.
Financial Advisors and Fiduciary Duty
Financial advisors who are fiduciaries must act in the best interest of their clients, offering the lowest cost financial solutions to fit their clients’ needs. But, it’s important to note, not all financial advisors are fiduciaries.
Anyone can legally call themselves a financial advisor and provide financial advice, making it particularly important you know what standard the person managing your money holds themselves to.
Most financial advisors, even if they aren’t fiduciaries, have to somewhat consider your interests when offering advice. Only fiduciary financial advisors have to place your best interest over theirs, though. Fiduciaries’ recommendations must consider your overall financial situation carefully, and they must offer the most economical solutions with the best performance. Because of this, you probably want a financial advisor who is a fiduciary.
Fiduciary financial advisors commonly work for RIAs. Certified Financial Planners (CFPs) are also generally fiduciaries, but make sure your CFP is acting as a fiduciary before starting business with them.
Financial advisors who work for brokerages generally are not fiduciaries. They are still, however, held to a lesser legal standard of care called the suitability standard. These non-fiduciary advisors must offer investment advice and product recommendations that are suitable for you. This means that the products generally fit your needs but may have higher fees or offer the advisor a bigger commission.
“When you have a fiduciary requirement, you have the highest standard for client service for advice and planning,” says Wes Brown, a fiduciary and certified financial planner at CogentBlue Wealth Advisors in Knoxville, Tenn.
How Are Fiduciary Financial Advisors Paid?
Financial advisors may be paid on commission, with fees or through a combination of the two. When you hire a new financial advisor, it’s important to ask if they are a fiduciary and how they make their money. This helps you gauge for yourself any potential conflicts of interest. Advisors are commonly paid in the following ways:
Commission-Only Financial Advisors
Commission-only advisors only make money when they sell investments or a particular financial product. Often, commission-only financial advisors are employed by broker-dealers and are only held to a suitability standard. Make sure a commission-only financial advisor is a fiduciary or that you fully understand the products and fees being sold to you before doing business with them.
Fee-Only Financial Advisors
Fee-only advisors only make money from client fees. These might come as flat or hourly fees or as a percentage of all of the assets they manage for you. They do not earn commissions on investments, nor do they get a fee when you buy or trade securities. Because of this, fee-only financial advisors generally have fewer conflicts of interest than other advisors, and they still must disclose any conflicts they do have. Fee-only financial advisors are almost always fiduciaries.
Fee-Based Financial Advisors
Fee-based advisors may have fees like fee-only financial advisors, but they also may earn money from commissions or referral fees, like commission-only advisors. If you choose a fee-based advisor, you want to make sure they are always acting as a fiduciary. Some fee-based advisors may not act as a fiduciary when they perform certain tasks. It’s important to note that just because an advisor receives a commission for a product, that doesn’t necessarily mean it’s not in your best interest. Certain products, like life insurance, may only be sold with a commission-based model, says Karen Van Voorhis, a certified financial planner and Director of Financial Planning at Daniel J. Galli & Associates in Norwell, Mass.
Many financial advising professionals advocate for people to use fee-based and fee-only advisors. That’s because someone who you are paying a fee to, instead of someone being paid a commission by a company, may prioritize your financial wellness more than someone who will make money regardless of if you return to them in the future.
Choosing a Fiduciary Financial Advisor
To find a fiduciary financial advisor, follow these steps:
- Think about your goals. Before researching advisors, establish what your financial goals are. For instance, you may be planning on retiring early, funding your child’s college education or buying a home within the next five years. Some financial advisors specialize in particular areas, so you want to make sure you find an advisor whose experience matches your goals and background.
- Research financial advisors. Word-of-mouth from family and friends can help you find a reputable fiduciary financial advisor. You can also search for advisors on the National Association of Personal Financial Advisors (NAPFA) database, Garrett Planning Network, XY Planning Network or the Alliance of Comprehensive Planners (ACP).
- Review potential advisors’ Form ADV. Investment firms are required to file The Uniform Application for Investment Adviser Registration (Form ADV) with the SEC annually. This form, available for review on the SEC website, outlines the firm’s services, fees, credentials and disciplinary history. FINRA’s BrokerCheck also lets you research any complaints filed against fiduciary financial advisors.
- Meet with the advisor. You need to feel comfortable with your financial advisor, so you should meet with your prospective advisors to ensure you agree with their investing philosophy and that they understand your goals and risk tolerance. Your relationship with your financial advisor is ongoing, so feel free to ask questions and request more information. Make sure you leave any first meeting knowing how your advisor makes money and if they are a fiduciary.