Chances are you have used a fiduciary at some time, and chances are you've been a fiduciary to someone else as well. Whether or not you can define the term, the fiduciary plays a critical role in finance and in life.
A fiduciary, in any context, is a person who is ethically or legally obliged to act in the best interests of another party. A doctor or an accountant takes on a fiduciary role.
A fiduciary investment advisor is required to choose investments regardless of self-interest or the interest of any other party. An investment advisor who is not a fiduciary follows a less-stringent code requiring that investments be suitable to the client.
- A fiduciary has an obligation to act in the best interests of another party.
- A fiduciary investment advisor is obligated to choose investment products that are in the best interests of the client regardless of self-interest or a third party's interests.
- Registered investment advisors (RIAs) have a fiduciary duty to clients while broker-dealers must meet the less-stringent standard of suitability to the client's needs.
- Fiduciary law is complex, and it can take a blatant misdeed to prove a breach of trust.
What Is a Fiduciary?
A fiduciary relationship involves two parties: the fiduciary and the client. Fiduciaries commit to putting the client's needs in front of their own. This is considered the highest standard of care under the law.
In practical terms, it often comes down to who's paying whom. An investment advisor may receive a commission for selling certain investment products, raising a potential conflict of interest between the client's interest and the advisor's own interest.
Unfortunately, not all fiduciaries always meet the highest standard. In addition, there are specific risks to consider when entering into a fiduciary-client relationship. Here are five factors to consider to protect yourself and your assets.
Misconception #1: Everybody Is a Fiduciary
There are two standards of care that apply to money managers: the fiduciary standard and the suitability standard. The fiduciary standard requires the professional to act in the best interests of the client. The suitability standard requires that a financial advisor make recommendations that are suitable for the needs of the client.
The fiduciary relationship may be defined by law. For example, a court that appoints an executor to an estate may mandate that the executor do the job to a fiduciary standard.
In other cases, the fiduciary duty is a professional commitment. For example, a certified financial planner (CFP) is bound to the fiduciary standard by the Code of Conduct of the National Association of Personal Financial Advisors (NAPFA).
Misconception #2: There Is Always a Test or License
Fiduciaries gain the designation by actions, not education. Some fiduciaries are chartered financial analysts (CFA) who went through a grueling process to gain the certification. Others may have taken a test to become registered investment advisors.
Some take on a fiduciary role for a single purpose. A fiduciary can be hired by a company that needs an independent third party to oversee a process or plan. Volunteers for the investment committee of a non-profit agree to act in the best interest of the organization.
3(16) Plan Administrators
A 3(16) fiduciary is a service provider hired by a company to administer its retirement plan. The plan administrator follows a set of duties to ensure that the plan is in compliance with regulatory guidelines.
Misconception #3: Fiduciary Law Is Easy to Enforce
Fiduciaries who breach their duty may face tough civil and criminal penalties, but it can be difficult to prove in court.
Moreover, they can do their duty towards their clients and still lose money for the client.
For example, imagine you ask your financial advisor to shelter your portfolio from risk even at the expense of sacrificing potential profit. The advisor puts some of the money into blue-chip stocks, which promptly crash in value. The advisor has not acted in bad faith.
Misconception #4: A Fiduciary Guarantees a Profit or Protection from Losses
Under industry rules, no financial advisor can guarantee that you will profit from any investment. If you don't see the results you were hoping for, that doesn't mean that your advisor breached a fiduciary duty.
Hiring a fiduciary is not a guarantee against an unfavorable outcome. You can still experience investment losses when a fiduciary is managing your portfolio.
The Employee Retirement Income Security Act of 1974 (ERISA) set the minimum standards for most retirement plans. To ensure compliance with these rules, companies often seek a fiduciary to act as an independent third party overseeing their plan.
Misconception #5: Fiduciaries Are Always Honest
Most financial advisors are in the business to help you manage your money and reach your long-term goals. They will not knowingly advise you to take actions contrary to your best interests. Being a fiduciary means that you uphold your client's interest first and are not self-serving.
Still, some people will be bad actors and violate the rules of fiduciary conduct.
Are Fiduciaries Trustworthy?
Fiduciaries hold positions that demand trust. This is not to say that trust cannot be broken.
If you are handing your money over to someone else to manage, you still need to keep an eye on your financial affairs. It's not about being suspicious. It's about being proactive.
How Can You Tell If Someone Is a Fiduciary?
Fiduciaries have no need to keep their status confidential. Actually, they have an incentive to advertise their fiduciary commitment in order to promote confidence in their services.
if you are wondering whether an investment professional is a fiduciary, just ask.
How Do Fiduciaries Get Paid?
In the personal investing business, a fiduciary advisor may collect fixed fees, commissions, or a percentage based on assets under management (AUM) for overseeing a client's portfolio.
There are fiduciary relationships in many other fields. A doctor is a fiduciary to a patient, and an accountant is a fiduciary to a client. They are paid according to their own industry practices.
The Bottom Line
Expect a high standard of service from a fiduciary, but don't let your guard down. Nobody cares more about your money than you do.
You don't need to be an expert, but you should have enough knowledge to be able to make informed decisions about all of your financial affairs.