Whether or not you hire a fiduciary to handle your investments and financial planning needs is arguably the most important decision you will make when looking for a financial advisor. Unfortunately, this topic can be difficult to understand and sorting out the fiduciaries from non-fiduciaries can be rather confusing.
What is a Fiduciary?
A fiduciary is an individual or firm that is legally bound to act in the best interest of someone else. They cannot be swayed by how a decision could impact their own income. Someone is said to have “fiduciary duty” when they are acting in the capacity of a fiduciary.
On the other side, a non-fiduciary is an individual or firm that is not legally bound to act in the best interests of someone else. For example, a non-fiduciary financial advisor can accept payments from mutual fund companies to sell their funds, even when much better options are available for the client. Often the individuals who work for non-fiduciary firms are limited to funds or products that pay their company to be on the “approved list” of funds – often called “pay-to-play”. Or they may select funds based on how much commission they will earn on the product, regardless of quality.
Given this information, why would anyone choose a non-fiduciary for the important task of managing their assets and providing financial advice? This is where consumer education is so important.
The Financial Advisor Landscape
The basic understanding most people have about the financial advisory world is that there are two distinct camps - the brokerage (sales) side, and the registered investment advisor (RIA) side. RIAs are held to the prudent fiduciary standard and brokers are held to a “suitability” standard. Here’s an example: A candy bar may be “suitable” for lunch, but a balanced meal would be a more prudent option.
At the surface it seems like all advisors would want to be a fiduciary, but there is one rather large reason everyone isn’t working in this camp - revenue. Being a fiduciary means giving up the lucrative commissions and incentives that the non-fiduciary world enjoys. The bottom line is that advisors working as fiduciaries often make much less money than those with a sales focus. Make no mistake – that extra revenue comes from client accounts, whether the client sees it or not.
According to research done by Tony Robbins for his best-selling book Unshakable: Your Financial Freedom Playbook, there were 308,937 financial advisors in the United States when he did his research a few years ago. Of them, roughly 279,000 are brokers, or salespeople, mostly working for large national firms and not acting as fiduciaries. Of the remaining 31,000 who work for RIAs, 26,000 are identified as “dual-registered”, meaning they can act as both a fiduciary and non-fiduciary broker (salesperson). That leaves us with the elite 5,000 or 1.6% of the entire group who work as true fiduciaries 100% of the time. In his book, Tony recommends only working with those who are true fiduciaries – those in the elite 1.6%.
Tony Robbins discusses this phenomenon while being interviewed for his book. You can watch the video here. It is a very informative two minutes and thirteen seconds.
If you’d like to search on your own, go to YouTube and look for “Tony Robbins Explains the Meaning of a Fiduciary.”
If it Only Costs 1% - 3% More for a non-Fiduciary, does it Really Matter?
Extra costs can manifest themselves in such things as higher cost mutual funds - sometimes with sales loads, excessive advisory fees, inefficient portfolio design, high-cost insurance or structured products, bid-ask spreads on stock and bond trades, selling securities from their own book, inefficient rebalancing, lack of attention to tax implications, sales commissions, etc.
The graph below shows ending values for $100,000 growing at 5%, 6%, 7% and 8% annually. During short periods of time, the differences can seem minimal, but over time, the difference is significant. The investor earning 5% over 30 years has just over $400,000 while the investor earning 8% has over $1 million. Yes, it matters.
There are also many other benefits that are more difficult to quantify but can save clients tens or hundreds of thousands of dollars. Fiduciaries get engaged with tax planning, cash flow strategies, Social Security optimization, gifting strategies, estate planning, risk management (without selling insurance), and overall comprehensive financial planning for their clients. Non-fiduciaries too often feel the pressure to “produce”, which means to sell more products that generate revenue for them and their companies, instead of the time-consuming business of helping clients achieve financial freedom in the most efficient manner.
How Can You Tell Who is Who?
Once a basic understanding of fiduciary duty is understood, the next step is learning how to tell the difference between a non-fiduciary, part-time fiduciary, and a full-time fiduciary. Let’s keep it simple and split the financial advisory world into two distinct groups – those who are true full-time fiduciaries (roughly 1.6% of advisors) and those who are not full-time fiduciaries (the other 98.4% of advisors). One of the easiest ways to determine who is who is to look for certain words, phrases, or disclosures on their website.
Words associated with fiduciaries:
Fiduciary*, Fee-only, Registered Investment Advisor (RIA)**, National Association of Personal Financial Advisors (NAPFA)
*Unfortunately, it seems like everyone uses this term now
**Most who claim to be fiduciaries are “dual-registered” firms who are RIAs and brokers (salespeople)
Words associated with non-fiduciaries or part-time fiduciaries:
“Securities offered through…”, FINRA, SIPC, Insurance, fee-based, annuities, brokerage, broker-dealer, Registered Representative, “Affiliated with…” Series 7, Member New York Stock Exchange, BrokerCheck
These are all indicators that the firm is not acting as a fiduciary. Other red flags are companies who go through multiple name changes or affiliations. They can have confusing or vague business structures that are too often put together for purposes of creating additional revenue streams for themselves at the expense of the client.
The non-fiduciary group is also the one who entertains quite a lot and offers free dinners to have people listen to their sales pitches. Buyer beware!
Many of the very best financial advisors have no securities or insurance licenses. This is often surprising to people until they realize that these licenses are earned to sell products.
The Advisor Claims to be a Fiduciary but What About Their Firm?
This is another very tricky area. Many individual advisors claim to be or act like fiduciaries, or have designations that suggest they are fiduciaries, but they work for firms that are not fiduciaries. It is important to make sure all parties are acting under the fiduciary umbrella – that includes the individual advisor and the firm they work for. Many industry experts recommend getting in writing that your advisor and the firm they work for are acting as true 100% fiduciaries.
The Most Qualified Advisors Are Drawn to True Fee-Only RIAs
This shouldn’t be a surprise. Financial advisors who’ve spent years studying and learning about investments and financial planning don’t need to rely on sales skills to make a living. The value they provide is from their expertise and experience as a fiduciary, not sales seminars. They are driven by the desire to help people by using their financial skills and have no desire to sell mediocre, overpriced products.
If you have been misled or confused by the definition and/or application of fiduciary duty, you’re in good company. There is a billion-dollar industry that profits from this misunderstanding. They can afford to hire the best marketing and PR firms money can buy. The best advice for the consumer is to ask any potential advisor for documentation ensuring that the individual advisor and the firm they work for are “true 100% fee-only fiduciaries” when working with all types of clients and accounts. Here is a sample form you could ask them to sign. Fiduciary Pledge.pdf
You can now consider yourself in the elite educated consumer group. Just like the “future you” will be thankful you passed on the junk food; wise financial decisions today could pay dividends in the future worth millions.