There is ever changing terminology in the financial services industry, and it’s getting quite complex. There are advisors, analysts, certified financial planners, brokers, and now, fiduciaries. This is a recent addition to the financial vocabulary, and understanding what it means, will be crucial if you’re looking to choose a new financial advisor. Only a fiduciary advisor is both ethically and legally required to put your best interest before their own.
What is a Fiduciary?
A fiduciary is a person or legal entity that is given the power to act on behalf of another, and to put their interests first, in situations requiring total trust and a fiduciary duty is often regarded as the highest standard of care. It simply means always acting with the best interest of the beneficiary in mind. For the financial advisor, this could mean recommending a company or decision that results in a reduced compensation just because it’s the best option for the client.
The Investment Advisors Act of 1940 is a law that was enacted in order to regulate advisors who, for compensation, give advice. This is regarding the value of securities, or the advisability of investing in, buying or selling securities. The law establishes principles for the relationship between advisors and their clients, which courts have interpreted to be a fiduciary obligation.
According to the Securities and Exchange Commission rules and the Investment Advisors Act of 1940, the five responsibilities of a fiduciary are as follows:
- Put the client’s interests first
- Act with the utmost good faith and loyalty
- Provide full and fair disclosure of all facts
- Do not mislead the client
- Expose all conflicts of interest
Fiduciary vs. Suitability
The most common difference between a fiduciary advisor and one acting under suitability standard occurs in their decision making process. For advice to be considered “suitable,” all the financial professional needs is an adequate reason to believe a recommendation fits the client’s financial situation. And according to USNews, the suitability standard does not require advisors to put their clients’ best interests before their own, nor must they avoid conflicts of interest.
Before ever making a financial recommendation, fiduciaries undergo a thorough process designed to determine what exactly is in their client’s best interest. After making a recommendation, they discuss all of the details in their entirety with the client to ensure there’s no misunderstanding about the recommendation and the fiduciary’s rationale for making it.
When you’re in the market for a financial planner, make sure you find a fiduciary one. At this current time, it is only independent registered investment advisors who are required to act in a fiduciary capacity. Brokers or financial advisors working for a broker-dealer firm or an insurance company are only held only to a suitability standard.