You may be reading this article if you are looking for a financial advisor but not quite sure which one to choose or what issues to consider before hiring one. A good starting point is to determine if your potential financial advisor is working under a fiduciary standard and legally bound to act in your best interest, or if he/she is working under a suitability standard, which is considered a lower standard of care.
Fiduciary standard of care versus suitability standard of care
The words “fiduciary” and “suitability” may be new to you, so let me provide you with an overview of each term as it relates to your investments and overall financial well-being.
In the financial advice industry, the fiduciary standard is considered the highest level of care a financial advisor or financial planner can operate under. Under the fiduciary standard, your financial advisor has a duty of loyalty and care to you, is required to legally act in your best interest, and must put your financial interests above his or her own. This is similar to the same legal level of care you would expect from your doctor, lawyer or CPA. In addition, if there are any conflicts of interest, they must be disclosed in writing, along with any fees or compensation.
The fiduciary standard is aligned with Registered Investment Advisors (RIAs) who are licensed under the SEC or in their state of business. RIAs are governed under the Investment Advisors Act of 1940.
In contrast to the fiduciary standard, the suitability standard means a financial advisor can provide advice and financial products that are considered suitable for you based on a basic understanding of your financial situation. One of the key defining differences in this definition is that “suitable” means there could be better investment options, but what is being recommended to you meets a suitable or reasonable solution. For example, the financial advisor may have access to investment options that are lower cost, better diversified or pay a smaller commission to the advisor, but the advisor could choose to recommend the investment option that pays him or her a higher commission as long as the investment product was deemed suitable for your financial situation. I think you can see the potential conflicts of interest that could exist in such a scenario. Whereas the fiduciary standard requires that a financial advisor eliminate any conflict of interest, or at least disclose any conflict of interest in writing, the suitability standard has no such requirement.
Commonly financial advisors that are aligned with a broker-dealer and practice under the suitability standard are stock brokers, insurance agents or may work at a bank. They are licensed under a different governing body called FINRA.
How do I determine if my financial advisor is acting under a fiduciary standard or a suitability standard?
- The easiest way is to ask them directly. Will you be acting under a fiduciary standard of care and are you willing to put that in writing?
- Are you a Registered Investment Advisor (RIA)? Can I see your form ADV? The form ADV is the regulatory document under the SEC or their state of business that provides an overview of their RIA firm, services to be provided, fee structure and discloses any typical conflicts of interest.
- Another option is to ask them what types of securities licenses they hold. A financial advisor providing advice as a fiduciary is licensed as an RIA under the Series 65 license. A registered representative selling financial products under a suitability standard is typically licensed under a Series 7 (stock broker’s license) and/or Series 6 (mutual fund and variable annuities) license.
What about the new fiduciary regulation that was to go in effect on April 1st 2017?
Due to great consumer demand for working with a fiduciary, the Department of Labor created a law that was to go in effect beginning April 1st 2017 that would require all financial advisors working with IRAs or retirement accounts to provide advice under a fiduciary standard. Many are calling this “fiduciary lite” as it was not quite as stringent as the fiduciary standard that RIAs currently operate under. However, it was a much needed step in the right direction for the financial services industry. Unfortunately, the new presidential administration requested a hold on this new law and asked that it be further reviewed before being implemented. At this point we don’t know if it will be delayed for only a period of time, face changes prior to implementation, or be completely eliminated altogether.
So where can I find a financial advisor or financial planner that operates as a fiduciary?
The good news is there is a great option currently in existence that will allow you to work with a fiduciary based financial advisor – The National Association of Personal Financial Advisors (NAPFA), or www.NAPFA.org. On their website you can search nationwide for a financial planner that is near you. In full disclosure, I am also a member of NAPFA. One of the great things about NAPFA is all financial advisors that are affiliated with this organization proactively chose to act as a fiduciary for their clients. Not only do they act as fiduciaries, but they are also fee-only and do not sell any commissioned financial products. For more information on types of financial advisor compensation, please see my article titled “What is the Difference Between Fee-Only and Fee-Based?”
In conclusion, if you want unbiased and transparent financial advice, then consider working with a Registered Investment Advisor that holds themselves out as a fiduciary and is willing to put that in writing.
