What is a fiduciary?
Fiduciary comes from the Latin word for "trust." A fiduciary has a legal obligation to act in the best interests of their clients. Lots of people can be fiduciaries placed in trusted positions: lawyers, trustees, legal guardians, and investment advisers. More specifically, an investment adviser owes their clients a duty of care and loyalty. This duty includes providing advice that is in the clients' best interest, acting in the utmost good faith, and providing full and fair disclosure of all material facts, fees and conflicts of interest.
So what does that mean and why is it important?
Most clients think this is a no-brainer-- "of course my advisor should act in my best interest." The truth is that not all advisors are required to provide services under the fiduciary standard. For instance, broker-dealers (BDs) use the "suitability standard of care" which means as long as the recommendation is suitable then it's allowed.
Registered Investment Advisors (RIAs) fall under the "fiduciary standard of care" which is a legal obligation to advise and make recommendations that are in the clients' best interest (and above the advisers own interest). This is an important distinction because recommendations that may be "suitable" may not be in the best interest of the client.
So how do you tell who's a fiduciary and who's not?
RIAs and Investment Advisers (IA) adhere to the fiduciary standard. BDs and Registered Representatives (RR) currently use the suitability standard. You can tell typically by the type of compensation being received; IAs are upfront about compensation and typically charge advisory or financial planning fees, while suitability recommendations typically pay in the form of commissions to the RR.
Here's a checklist to know you're working with a fiduciary:
- You received an ADV (disclosure document provided by IAs detailing their services, fees, and conflicts of interest)
- You know how much you're paying (usually a percentage of assets under management or fixed rate)
- You know what services you're paying for (outlined in a signed advisory agreement)