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Investors need to know what being a ‘fiduciary’ advisor means

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Nearly anyone can hang out a shingle and just call themselves a financial advisor.

To be sure, the terminology in the financial services industry can be very confusing to investors. There are advisors, brokers, broker-dealers, certified financial planners, chartered financial analysts and certified investment management analysts, investment advisors, and wealth managers, to name a few.

Making that call and choosing what type of advisor you need or want to manage your finances is a big decision. And it really is a “buyer beware” situation when a person is looking for an advisor, according to Kevin Keller, CEO of the CFP Board, which sets and enforces certified financial planners’ standards.

However, the most important factor when choosing a financial advisor is that they be a fiduciary. A fiduciary has a legal duty to act in a client’s best interest. It’s also important to know that many advisors are not fiduciaries.

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The financial advisor who is a fiduciary owes the client a duty of loyalty, which means they must act in the best interest of the client. If a conflict of interest exists, the advisor must make full and fair disclosure of all material facts so the client can make an informed decision whether to proceed with a transaction.

Here are the five core principles of the fiduciary standard are:

  1. Put the client’s best interests first.
  2. Act with prudence; that is, with the skill, care, diligence and good judgment of a professional.
  3. Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts.
  4. Avoid conflicts of interest.
  5. Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

Those not working to the fiduciary standard are held only to a suitability standard, meaning their advice must be suitable for you. While these terms seem relatively similar, there is a reason that fiduciary duty and suitability standards are at opposite ends of the dictionary.

A fiduciary financial advisor must put your interests ahead of their own, and these individuals are typically fee-only, independent financial planners. The suitability standard most often applies to broker-dealers and commission-based advisors.

Suitability means that the investments the investment advisor recommends only have to be suitable, and not necessarily consistent, with the client’s objectives and profile. These advisors can still recommend their company’s proprietary products even if they are inferior to alternate investment options.

The suitability standard also allows these finance professionals to sell overpriced investment products on which they tend to make higher commissions rather than steering their clients towards lower-cost investment options. The advisor must only prove that the product is not unsuitable for their clients, and the product need not be in the client’s best interests.

“From my perspective, if you claim to provide financial advice to a client, you are obligated to act on the client’s behalf,” said Avani Ramnani, a CFP and director of financial planning and investment management at Francis Financial. “If you fail to protect your client’s rights, don’t call yourself an advisor or financial planner.”

It seems like a no-brainer to choose a financial advisor who acts as a fiduciary.

However, there is significant misinformation floating around that leads many individuals into a false sense of security.

Personal Capital funded a research study that found that nearly half of Americans erroneously believe all advisors are legally required to always act in their clients’ best interest. Not only is this wrong, but it can also be damaging to the millions of savers and investors who unwittingly expose themselves to biased and potentially dangerous advice from advisors who can do what is best for themselves, at the expense of their clients.

It is critical to speak a client’s language and educate them about the relevant facts and reasons for a particular recommendation.

Avani Ramnani

director of financial planning and investment management at Francis Financial

Another aspect of a fiduciary’s duty is to act in good faith and provide all relevant facts to clients. Part of this duty is to educate your clientele.

The financial industry is known to use terms that can be challenging to understand and overly complicated. A financial advisor must explain these concepts and their recommendations, as neglecting to do so can lead to misunderstandings, misinterpretations or misguided advice.

“As a financial advisor, it is critical to speak a client’s language and educate them about the relevant facts and reasons for a particular recommendation,” Ramnani said. “I liken this to teaching someone to play a musical instrument.

“To a novice, music terms makes little sense,” she added. “However, a skilled teacher breaks down all the obscure terms such that the new learner can understand, practice and improve their performance.”

A fiduciary must disclose any conflicts of interest, and all fees for services should be clearly explained, transparent,and detailed through specific written disclosure. If an advisory firm holds the highest standards for its clients, managing and fully disclosing a conflict of interest becomes a straightforward and easy process.

The need to disclose potential conflicts of interest is not as strict a requirement for non-fiduciaries and, unfortunately, some bad apples do fall from that non-fiduciary tree. Regulators have caught advisors overbilling, taking undisclosed fees, falsifying investment performance, churning accounts and lying about qualifications.

So, how does an investor protect themselves?

Regulators must continue to increase their efforts to clamp down on rogue advisors for failing to protect clients’ rights. Clearer lines must be drawn so that individuals can better delineate between fiduciaries offering real financial advice and advisors who are only interested in product sales.

In the meantime, the consumer has the tough job of scrutinizing the thousands of financial advisors and identifying who is a fiduciary and can offer them independent, conflict-free financial planning and investment advice.

Investors need to ask a financial advisor if they work as a fiduciary at all times. Also, ask your advisors to sign a “Fiduciary Oath” drafted by the Committee For The Fiduciary Standard to make sure that they meet the five core fiduciary principles.

—By Stacy Francis, CFP, president and CEO of Francis Financial

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