This article is also published in Investopedia and NASDAQ
You may have heard a great deal of discussion lately about something called the Fiduciary Standard and how it applies to investment advice.
The Fiduciary Standard has been around for hundreds of years. (Yes! The Fiduciary Standard can trace its roots to 17th century England.) Very simply put, it means you place your trust and confidence in the hands of a professional to take care of your financial needs. The professional fiduciary is expected to perform and advise you based on your best interests, even if it comes into conflict with the advisor’s own interests.
Not all investment advisors are held to this standard. Many brokers, registered representatives and insurance agents are held to a lesser standard referred to as suitability. They may offer you a product that may solve a problem. But did they keep your best interests at heart? Do they have a complete understanding of your financial situation?
A Fiduciary will have complete knowledge of everything about your financial life before making any recommendations.
Non-Fiduciary Broker:
- A broker may offer you a Variable Annuity or an Indexed Annuity and tell you that it will resolve all of your investment needs. What he may have failed to tell you is that the Variable Annuity comes with limited investment options, very high fees, and commissions. Also, the Variable Annuity has steep penalties if you try to cash it out early. Usually you must keep these things between 8-10 years — some of them longer. He also may neglect to tell you that the sale of the Variable Annuity qualified him for an all-expense paid lavish trip. He knows that a couple of low-cost mutual funds would have done the same thing with much less cost, but his commission would have been lower, and he would miss out on that trip (that you indirectly paid for). In whose best interest did your broker work? Did he disclose to you the commission or the trip he would earn?
- The broker is not held responsible if the product he sells you didn’t work out. He will most likely fail to provide ongoing oversight or service. You can only hold him responsible if you can show that what he sold you was inappropriate (unsuitable). An example of an inappropriate sale would be to invest most of your portfolio into something with no liquidity and no exit strategy.
An Investment Advisor held to Fiduciary Standard…
- …is going to take the time to learn what the issues are that need resolution, then he will place you into an investment portfolio that will best suit your needs. He will also resolve any conflict of interest by not taking any commissions or going on any company-paid trips. The conflict resolution is resolved through a fee arrangement between you and the advisor. It is further reconciled with disclosure of any potential conflicts of interest. This way you know that he is working in your best interest.
Non-Fiduciary vs. Fiduciary Approach:
- A broker, non-fiduciary, while making sure the product is appropriate for you, very often takes the approach of a solution (product) looking for a problem.
- A Fiduciary will take the exact opposite approach by recognizing the problem first, then finding a solution. Once a Fiduciary builds a plan for you, he has a responsibility to execute and monitor that plan for as long as you remain his client. If something goes wrong, he will make every effort to fix it. A good advisor will have performed Due Diligence on any and all products he uses as investment tools. He also will perform Due Diligence on any outside advisors he might recommend.
Further, a Fiduciary is not bound to any one company. Brokers very often can be limited to the products offered by one company. Brokers very often maintain relationships with investment company representatives that promise expensive meals or lavish outings to win the brokers business. This is very similar to a Washington Lobbyist who curries favor with your representatives in Congress. A Fiduciary will avoid all of that.
Think of it this way:
You don’t feel well, so you go to your doctor to find out what is wrong. He does a cursory exam then writes you a prescription. He then informs you that there is no charge for the office visit, however you will need to fill the Rx at the pharmacy across the hall. No need for a follow up visit! What he didn’t tell you is everybody is given the same Rx, no matter the illness. He further failed to disclose that the pharmacy gives him 8% on every prescription they fill for his patients. Now the pharmacist tells you that the doctor wrote you a prescription for a Generic Rx. The pharmacists lets you know that the name brand might be more effective, yes it is more expensive, but don’t worry its covered by insurance.
You may or may not have received the right medicine for your illness, but in whose best interest are the doctor and pharmacists working? Yours or theirs?
Determining the ‘Real Deal’
How can you determine who is an Investment Fiduciary and who is working on commission? If your advisor carries a designation such as Certified Financial Planner (CFP®) and presents himself as an Independent Registered Investment Advisor (RIA) then you have the ‘Real Deal’.
- An RIA only works on a fee arrangement between his client and his firm. He accepts no outside compensation, gifts or gratuities. Additionally, an RIA is governed by the Securities act of 1940 which puts into law the Fiduciary Standard.
- A CFP® is governed by the CFP Board of Standards which maintains a high degree of fiduciary responsibilities for its designees. Those standards include Integrity, Objectivity, Competence, Fairness, Confidentiality and Professionalism.
Finally, don’t be fooled if an advisor tells you that his advice will cost you nothing. That is just silly. Of course, his advice comes with a cost, only it is built into and hidden in the product he sells you. He just failed to disclose the cost. If the investment underperforms or fails, then it cost you even more.
Eugenio Financial is a Registered Investment Advisor (RIA), and Michael Eugenio is a Certified Financial Planner (CFP®).
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