Fiduciary: What It Means And Why It’s So Important

A financial fiduciary is a person or organization that has the legal responsibility to manage money for another person or organization on their behalf while adhering to a high duty of care.

There is no legal requirement for a financial advisor to put their clients’ best interests above their own. While some may claim to provide advice that serves clients first, even if it means less money for them, the only assurance that that is actually the case is if they are a fiduciary.

Fiduciaries follow a code of ethics that requires them to act solely in the best interest of their clients. Some organizations withhold membership affiliation or professional designations for those who don’t adopt the fiduciary standard of care:

• The National Association of Personal Financial Advisors (NAPFA) — a leading organization of fee-only financial advisors that requires its members to adhere to a fiduciary standard — requires its members to proactively disclose any conflicts of interest that might impact their clients.
• Advisors who hold the certified financial planner (CFP) designation are also required to act as fiduciaries.

Not all financial advisors are fiduciaries, though some advisors may obscure this fact.

Fiduciary duty vs. suitability standard

Financial advisors are typically held to one of two types of standards when it comes to advising clients: a fiduciary standard or a suitability standard. The differences between the two reveal the differing levels of care that an advisor must show to clients.

• What is the fiduciary standard?
  

  An advisor adhering to their fiduciary duty to a client will do additional due diligence to ensure that any investment vehicle or financial product is not only suitable — or appropriate for their client — but also the best choice there is.

• What is the suitability standard?
  

  Suitability means that a financial product is suitable or may be a good fit for somebody in your general situation. This might be defined as someone who is the same age and marital status as you are, and whose income is roughly similar to yours. But an investment or financial product that is generally suitable for you may not be the best product for your situation. Plus, this opens the door for an advisor’s recommendations to be tainted by bias (for example, favoring products that kick back financial incentives to the firm over ones that don’t).

Here’s how the suitability versus the fiduciary standard can play out for a client: Let’s say two advisors are hired to pick a mutual fund for a retirement investment portfolio. There are two funds that meet the investment criteria, but one charges a higher management fee, which will cost the client more over time. Additionally, the firm earns a referral fee from the fund company for the higher-priced fund.

The non-fiduciary advisor can recommend the higher-fee fund — which is, in many regards, a fine product — and meet the suitability standard. The fiduciary advisor, however, must consider what’s in the client’s best interests as well as disclose any potential conflicts of interest (the firm’s financial relationship with the fund company). Their duty is not just to find a suitable investment, but also the lowest-cost one, all else being equal.

Fiduciary vs. financial advisor: How they differ

Financial advisor is a catch-all term that includes many different types of advisors. 

Just because someone calls themselves a financial advisor, however, does not mean they are a fiduciary. It’s important for potential clients to know the differences. 

For example, investment advisors registered with the U.S. Securities and Exchange Commission (SEC), as well as with many states, have a fiduciary duty to their clients and must disclose any conflicts of interest that could influence the advice they give.

In contrast, many advisors working through broker-dealers may be held to a fiduciary standard in some of their dealings, but in other areas are only required to follow the less stringent Regulation Best Interest standard, or Reg BI, as set forth by the SEC. 

Still, other financial advisors may not even have that lower standard of care. So it’s vital that consumers understand what standard a potential advisor works under, if any, and what obligations they have to their clients.

Here’s more on the differences between a fiduciary and a financial advisor.

To be clear, there are many excellent advisors who are not fiduciaries. These practitioners care deeply about their clients and do an outstanding job. Similarly, some advisors who are fiduciaries may lack the knowledge and experience in dealing with clients in your specific financial situation.

Breach of fiduciary duties: What are the potential legal consequences?

Breaches of fiduciary duty are serious matters with potentially significant legal consequences. 

If a fiduciary breaches their duty, the victim can file a lawsuit and potentially receive compensatory damages as a remedy. Compensatory damages are intended to return the victim to the position they were in before the breach. If the fiduciary’s actions are intentional, egregious or malicious, courts may also award punitive damages.

In some instances, breaches of fiduciary duty may result in criminal charges, which could lead to jail time for the convicted advisor.

3 questions to ask before you hire a financial advisor

It’s in every investor’s best interest to work with an advisor that is professionally committed to acting in your best interests.  Any reputable advisor will be happy to clearly answer your questions about how they are paid and any potential conflicts in how they operate. Here are three to start with: 

1. “How are you compensated?”

Ideally, you should seek out advisors who are fee-only. This means that all compensation they receive is paid by their clients, not by the providers of investment and financial products. Financial advisors are human, and they can be tempted to sell clients financial products that offer the highest compensation to them, whether or not these products are the best choices for their clients.

2. “Are you a fiduciary? If yes, will you put this in writing?”

Any advisor who is truly a fiduciary advisor will gladly do this, often without you needing to ask. If an advisor claims to be a fiduciary but is hesitant to put that status in writing, that should be considered a huge red flag.

3. “Are there any conflicts of interest that you have that would preclude you from providing advice that is totally in my best interest?”

An example of a conflict of interest could be that the advisor’s firm may require certain types of investment products for clients.

Bottom line

Determining whether a financial advisor is a fiduciary is only one step in the process of choosing the best financial advisor. The advisor’s area of expertise, experience working with clients with similar financial goals or challenges and your level of comfort with them are all important factors as well. 

Most advisors offer a free initial consultation to see if your needs and their offerings are a match.