In recent years, you’ve likely heard the term “fiduciary advisor” in many financial services advertisements with greater frequency.  It is a very important distinction to make when deciding the type of financial services firms that you may be working with. But what is a fiduciary and why should you choose to work with one? I’d like to offer some general information and our view on the importance of this topic.

Put simply, a fiduciary advisor is one who establishes and abides by a code of ethics that is designed to always keep the best interests of their clients ahead of their own. 

Financial Advisors: Fiduciary vs Non-Fiduciary

Securities law is certainly not the most riveting content for the average investor. But bear with me as I highlight some important distinctions to be aware of when selecting an advisor. In the scope of this discussion, I’ll keep this general in nature. Here are the three primary topics that distinguish a fiduciary from a non-fiduciary:

• Duty of care
• Compliance and regulatory oversight
• Compensation structure

Client Best Interest First—ALWAYS!

As noted earlier, prioritizing the client’s best interest is generally considered the hallmark of a fiduciary. This should be common sense, right? Shouldn’t the client’s best interest come first for any advisor? You would think. But there is an important distinction to be made about what it means to put the client’s best interest first. 

It ultimately boils down to ethical practices. Under the fiduciary’s best interest duty of care, the advisor must always put the client’s best interest ahead of their own, even if it means not earning any income or opening up that new account and increasing their assets under management (AUM). If it’s not best for the client, a fiduciary shall not make the recommendation. 

A non-fiduciary, on the other hand, is not generally held to the same standard—or at least, not to the same level of scrutiny. Instead, they operate on a “suitability” standard. Something may be suitable on paper—but is it really in the client’s best interest as an individual investor?  Maybe. Or perhaps the recommendation or transaction is motivated by the advisor’s desire to earn a sales commission. We playfully call this “commission breath,” and it stinks!

I’d like to add that recent regulatory action under Regulation Best Interest (Reg BI) has increased the duty of care standard for most industry professionals.[1]

Disclose, Disclose, Disclose

Fiduciary advisors must also abide by more stringent disclosure requirements. One of the goals of a fiduciary advisor is to eliminate conflicts of interest. But just by the nature of a for-profit service, not all conflicts can be eliminated completely. However, with thorough disclosure of any potential conflicts, the client is afforded the opportunity to make informed decisions on how they would like to proceed. The topic of conflicts of interest leads me into what I believe to be the most important distinction between a fiduciary and a non-fiduciary advisor: compensation.

You Mean We Get Paid for This?

Of course we do! As with most professional services, there is significant education, time, and risk involved to get to where we are as a firm, and it doesn’t come easy or for free.  Regardless of which financial services firm you choose, here are three questions you should be asking EVERY professional you work with:

• How do you get paid?
• How much do you get paid?
• Where are the conflicts of interest or how does your compensation affect me?

The answers to these questions offer a critical distinction between a fiduciary and a non-fiduciary.

Commission vs. Fee-Based

Commissions are generally a percentage-based charge paid to the selling agent at the time of transaction—in some cases, through a series of subsequent payments. Commissions are paid by the entity issuing the product, such as a mutual fund company or an annuity/insurance company. But let’s not be mistaken, the source of the funds that pay the commissions come from you, the investor, in one way or another. To compound the concern, what incentive does the selling agent have in the success of their recommendation after the transaction has been made and the commission paid?  Financially speaking, there is little to no incentive.  As a compliance supervisor for the past 10 years, I get heartburn at the thought of commissions-based sales. I have yet to hear a truly convincing explanation of how this is NOT a conflict of interest no matter how thoroughly disclosed to the client. 

So, what about a fee-based arrangement?  Well, that is generally how a fiduciary advisor is compensated for their services. In lieu of one-time or transaction-based commissions that are promised by the issuing company, fee-based fiduciary advisors generally align their best interest (making money) with the client’s best interest (assuming that is to also make money). They are not paid transactional commissions, nor are they financially motivated to choose one fund company over another. When entering a fee-based advisory agreement, the advisor will typically offer a suite of services for a percentage-based fee to be assessed to the account on an annual basis. This advisory fee percentage amount remains the same, but if the underlying pool of billable assets increases in value (good for the client), the advisor will earn a higher dollar amount in compensation (good for the advisor).  Conversely, if the pool of billable assets shrinks in value due to poor performance, the dollar amount paid to the advisor is also a smaller amount. This practice financially incentivizes the advisor to grow and protect clients’ assets which, in my opinion, is clearly a win/win. As with any compensation structure, there is still an underlying financial incentive. But this practice at least attempts to better align the success of the client with the success of the advisor in a much more transparent way than the commission-based model.

Ask Questions!

Be proactive and advocate for yourself when working with an advisor.  For a healthy advisor/client relationship, you must be comfortable with and trust in the actions of your advisor. If you are not, find someone who checks those boxes for you. A good, ethical advisor will answer every question truthfully and work to earn and maintain your trust. As I like to tell my clients, I am the guide that you hire to help you safely navigate, but you are still the owner of the ship. You tell me where you’d like to go, and which route you’d like to take, and we’ll get there together.

Thank you for reading and I wish you continued success!

[1] Regulation Best Interest and the Investment Adviser Fiduciary Duty: Two Strong Standards that Protect and Provide Choice for Main Street Investors https://www.sec.gov/newsroom/speeches-statements/clayton-regulation-best-interest-investment-adviser-fiduciary-duty