Not all financial advisors are created equally.
Some are salespeople looking to earn commissions from your investments. Others follow a higher standard to help you reach your financial goals in the best way possible.
There are many ways to see if a financial advisor may be a good fit for you. You can ask about their experience, make sure your personalities mesh well and ask for references.
One aspect that’s vital to check:
The standard your financial advisor must meet when making recommendations for you.
There are two general rules financial advisors fall under -- the suitability standard and the fiduciary standard.
Fiduciary financial advisors must provide a higher level of care. When recommending products and services to their clients, they must be in the clients’ best interests.
Advisors that use the suitability standard may not always have their clients’ best interests in mind. Instead, a recommendation must merely be suitable.
Here’s how fiduciary advisors compare to those using the suitability standard and other aspects you should be aware of.
What Is a Fiduciary Advisor?
A fiduciary financial advisor is one that has agreed to be a fiduciary on your behalf.
They have a fiduciary duty to keep your best interests in mind when making decisions about how to manage your money. This is important.
There is a wide variety of investment choices available today. Many investments may work for you.
The key is:
A fiduciary must pick the investment option that is in your best interest.
Here’s an example to help clarify the difference.
A financial advisor could be considering two mutual funds for you. They both have similar returns. One mutual fund pays the advisor a commission for selling it to you from the amount you invest. The other does not.
The non-commissioned mutual fund would result in you investing more money. This would allow you to earn more returns over time. It would be in your best interests compared to an identical product that offers advisors a commission.
An advisor following a fiduciary standard would be required to sell you the non-commissioned product. They wouldn’t be able to sell you the commissioned one.
What Is Suitability?
In some cases, financial advisors may not be fiduciaries 100% of the time.
In other instances, they may never be a fiduciary.
Instead of keeping your best interests in mind, these advisors only have to pick investments suitable for you.
These advisors must follow the suitability standard. The standard is governed by the Financial Industry Regulatory Authority (FINRA).
FINRA’s suitability standard has three main obligations for firms and their clients. According to FINRA, they are:
- Reasonable-basis suitability requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.
- Customer-specific suitability requires that a broker, based on a particular customer’s investment profile, has a reasonable basis to believe that the recommendation is suitable for that customer.
- Quantitative suitability requires a broker with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.
In the example above, both mutual funds are suitable. They have similar returns and goals.
However, an advisor that must follow a suitability standard could sell you the one that allows them to earn commissions.
This is true even if it isn’t the best fit for you. They’re allowed to do so because it is suitable. The advisor is financially incentivized to make this decision, too.
To make matters worse, some advisors may switch your investments often. They can switch you from one suitable investment to another. This allows them to increase their commissions with each purchase or sale.
Another name for this practice is churning. It can reduce your returns drastically over time due to the fees and commissions paid.
What Is the Fiduciary Rule?
The fiduciary rule was a Department of Labor (DOL) standard.
It was proposed and has recently been challenged and dismantled. The rule was supposed to expand the definition of fiduciaries that offer investment advice beyond the current scope.
The rule would have made all advisors fiduciaries if they’re working with retirement plans or are providing financial planning advice about retirement. This included some people that were previously governed by the suitability standard.
The DOL is working on a new fiduciary rule package but it is not yet final.
What Does Being a Fiduciary Mean for the Consumer
Having a fiduciary financial advisor may put some people’s minds at ease. You should still do your homework, though.
Advisors are only as good as the advice they give. If your advisor doesn’t have enough experience with situations like yours, it may put you at risk.
For consumers, a fiduciary financial advisor should remove any conflicts of interest. They must keep your best interests in mind. This means they shouldn’t sell you substandard products.
One advisor’s idea of your best interests may be different than another’s. That’s why it is imperative to find a fiduciary advisor that’s a good fit for you.
In some cases, advisors may be a fiduciary for specific issues but not a fiduciary advisor for all decisions.
Always ask an advisor if they’re a fiduciary 100% of the time or only in certain cases. Ideally, they’ll always be a fiduciary for you.
Advisors Can Charge on a Fee-Only or Fee-Based Model
Fee-only financial advisors are more likely to be fiduciary advisors 100% of the time. This is because they’re only compensated by you for their services.
They may get paid a flat fee, an hourly rate or an assets under management fee. What they don’t get is commissions for selling you products.
Fee-based financial advisors could result in potential conflicts of interest. They may receive payment directly from you in addition to commissions from selling products.
These are more often brokers or dealers rather than fiduciaries.
How to Find a Fee-Only Fiduciary Advisor for You
Finding a fee-only fiduciary advisor isn’t always straightforward.
You can ask friends and family for suggestions, but these advisors may not always be good for your specific situation.
Make sure you consider the source of the recommendation and investigate the advisor before moving forward.
Registered investment advisors (RIAs) and Certified Financial Planners (CFPs) are certain types of advisors. These are always fiduciaries. You can use the CFP’s website to search for CFPs near you.
What to Look for in a Fiduciary Financial Advisor
When you’re looking for a fiduciary financial advisor, you want to make sure they’re a good fit for you.
First, make sure the advisor is a fiduciary 100% of the time. Take time to discuss how they’ll be compensated for working with you, as well.
Next, schedule a consultation with potential advisors to make sure they can meet your needs. When talking with the advisor, make sure they mesh well with your personality. Tell them your goals. Ask how they can help you meet them.
Don’t forget to look up the credentials the advisor claims they have to verify them. Most advisors are honest, but it never hurts to check.
Check databases to look for disciplinary actions against the advisors. You can start by searching FINRA’s and the Securities and Exchange Commission’s databases. If they have items listed, ask the advisor about them to see what happened and how it was resolved.
Questions to Ask Before Hiring a Fiduciary Advisor
Finding the right financial advisor is often the product of how much effort you put into the search.
When interviewing potential advisors, consider asking them the following questions:
- Are you a fiduciary 100% of the time?
- What qualifications do you have?
- How do you get compensated for working with me?
- What experience do you have working with clients similar to me?
- What is your philosophy for successful investing?
- How can you help me improve my personal finances?
- What custodian will hold my assets?
- How do you account for taxes in financial planning?
- How often will we meet?
- How will we communicate when I have questions?
Chances are you’ll want to work with a fiduciary advisor. The key is finding a fiduciary financial advisor that best fits your needs.
An advisor should be able to give you financial advice to improve your finances. They should inspire you in a way that makes you want to take action on their advice.
Not all advisors will be a good fit. Make sure you interview them before deciding to work with them. Most importantly, ask about conflicts of interest before deciding on the best advisor for you.