Why does it seem that everyone in the finance world is suddenly talking about the word “fiduciary”? The White House, the Labor Department, the Securities and Exchange Commission and the Financial Industry Regulatory Authority are all discussing it, as are financial services firms, and it has quickly become a water cooler topic.
So, what is a fiduciary, and how is the title different from broker, agent or advisor?
To many people it may seem that this once-unfamiliar word has materialized out of nowhere, but it’s been around for a long time, mainly used by legal and financial professionals. A fiduciary is a financial professional who always puts clients’ needs ahead of his or her own and avoids or discloses conflicts of interest. The “fiduciary standard” describes the way financial professionals must treat their clients — it’s a standard of care that certain financial professionals must apply to every client and every business dealing.
Why titles are imporant
You may wonder why all this talk of roles and titles is necessary. Can’t we just assume that professionals who work in finance mean well and do the right thing for us.
Not always. Sometimes they owe their loyalty to their employer or to other companies whose products they are pushing. Figuring out where their loyalties lie can often be difficult.
This is where titles, credentials and a free background check come in. They’re designed to help you figure out whether the person you’re talking to is skilled, competent and aligned with your interests.
Here’s why titles are important: It’s entirely possible that a person you’re paying to give you financial advice is not a fiduciary, meaning that he has something other than your best interests at heart. He could instead be a broker, with sales quotas, products to sell and his own personal financial objectives at heart when he suggests certain investments. Brokers and others not required to adhere to the fiduciary standard are allowed to suggest investments that are merely “suitable” but do not necessarily put their clients’ best interests ahead of their own. This also applies to many insurance agents and financial advisors.
This can be a major problem for individual investors and certainly for things like 401(k) plans because it’s nearly impossible for laypeople to understand what type of financial advisor they’re talking to — a broker, an insurance agent or a fiduciary — and under what conditions. Yes, you read that last part correctly: There are some people who may be a fiduciary in some conversations and not in others.
But don’t worry, there are some ways to figure this out, and more help may be on the way.
Understanding the trust factor
The first thing to understand is that the term “broker” actually means something. People cannot work in finance and call themselves a broker unless they pass a test and stay registered with the appropriate authority. It then means that they are authorized to facilitate buying and selling listed securities (things such as stocks, bonds and mutual funds, for example).
“Financial advisor,” on the other hand, doesn’t mean anything in particular. Nearly anyone can call herself a financial advisor.
So, why do so many people use the title financial advisor?
It comes down to the trust factor. People are already anxious about their money. Whether you’re wealthy or buried in debt, it can be difficult to entrust your innermost financial secrets to someone. If you get the feeling that the person across from you is looking at you as a sales prospect, you’re likely to clam up. If you’re in a financial discussion and that person introduces herself as a broker or an insurance agent, she know she’s likely to have to work that much harder to earn your trust. “Financial advisor” feels warmer.
But now we’ve had many bank representatives, insurance agents, brokers, financial planners and maybe even credit card and credit counseling people using the title financial advisor. This has clouded the conversation. It’s no wonder financial advisors, by profession, are not entirely well regarded, even though the title sounds more trustworthy than others.
Clients eventually figure out if they’ve been sold something that’s not entirely in their best interests, by someone who is ultimately not liable because he is not subject to the fiduciary standard.
Because so many different types of people might be called financial advisor, it makes it nearly impossible for people to figure out who is helping them and who is selling them.
As far as retirement accounts and 401(k) plans, the person consulting is seldom a fiduciary. These potentially powerful savings vehicles have been taken advantage of for decades by various types of “financial advisors” who provide little tangible value to the plan. They are often there simply to sell products, at fees that are not justified.
Defining a fiduciary
So what exactly is a fiduciary?
Depending on which regulatory agency you ask, you may get a different answer, which means that even some financial professionals wrestle with whether they are a fiduciary, and under what circumstances.
A new proposal winding its way through the regulatory process in Washington includes a part not only defining who is a fiduciary but also creating a universal definition of the term. These proposals are getting opposition from certain circles. Some people who work in finance argue that moving every retirement account — or at least just those held by people who choose to work with an advisor — into a fiduciary relationship will harm the small investor.
That is a thinly veiled way of saying that the only thing motivating brokers to work with small investors is the lower grade of service they can offer, and the higher fees they can charge. If fees were reduced and services and liability increased, many brokers say they’d have to stop supporting small accounts.
This may not be a bad thing for smaller investors. Individual small accounts (depending on the firm, this is often described as anything less than $100,000, $250,000 or $1 million) might find better services at a lower cost by using a small financial services firm that adheres to the fiduciary standard.
To find out more about potential financial representatives, their credentials and what role they’re likely to fill, visit FINRA and click on the free “Broker Check” link. This site also links to the SEC. Between these two sites, you can learn a great deal about the skills, credentials and particular focus of any licensed professional.
A key question to ask people with whom you are considering working (especially where retirement plans are concerned) is whether they are a fiduciary. If they tell you yes, get it in writing.
For a free copy of the e-book “Financial Industry Designations Explained,” visit Plan Partners.
Learn more about Jonathan on NerdWallet’s Ask an Advisor.