In this article I assume that you either use a financial professional or firm to get help with your investments, or you are thinking about it. If you manage them yourself, which is a very good option if you are up to the task, then this article won’t be very relevant to you – your fiduciary standard with regard to your own money is probably greater than anyone else’s.
But if you use a financial professional (broker, adviser, insurance salesperson, etc.), you should be aware that both the Department of Labor (DOL) and Securities and Exchange Commission (SEC) are looking into rules to force all of them to follow a fiduciary standard, as opposed to the “suitability” standard that they have used in the past (don’t worry, I’ll explain the difference in this article).
I should probably state up front that I generally don’t like the idea of government agencies forcing people to do things they are not otherwise obligated to do. But on the other hand, some oversight in this area is probably needed. I hope they find an appropriate balance.
What exactly is the “fiduciary standard”?
The fiduciary standard simply means that advisers have to put their clients’ best interests ahead of their own. For instance, faced with two identical products but with different fees, an adviser under the fiduciary standard would be compelled to recommend the one with the lower cost to the client, even if it meant fewer dollars in the finance company’s coffers and his or her own pocket in the form of a sales commission.
This standard is good for you and me, but not necessarily as good for the adviser.
So, if a financial planner or adviser is held to the fiduciary standard, it simply means that:
- They must exercise best efforts to act in the best interests of the client.
- They must provide disclosure of any conflicts of interest.
- They must clearly explain how they make their money (upfront fees, asset-based fees, commissions, etc.)
Some of this is very subjective (“best efforts” and “best interests” can look different for different people). But if you’re like me, you’re probably wondering, “Hey, wait a minute, don’t these folks have to do this already?” Well, the surprising answer is…no, they don’t. The fact is that some types of advisers are already held to this standard, whereas others are not.
This may be over-simplifying things, but generally speaking:
- Registered investment advisers (RIAs) and their representatives do owe a fiduciary duty to clients.
- Insurance agents and stockbrokers do not owe (from a standards and practices standpoint) a fiduciary duty to clients.
In the case of insurance agents and stockbrokers, they earn their pay by selling you specific products, which can result in biased advice. They are, however, held to what is called the “suitability standard” another somewhat vague and subjective concept.
The “suitability standard” allows more wiggle room
The “suitability” standard gives agents and brokers more wiggle room, as it simply requires that investments fit a client’s objectives, time horizon, and investing experience.
Unfortunately, this standard can be met by recommending a less suitable option, as long as it passes the general suitability test. In my opinion, this can result in a conflict of interest relative to compensation (which is typically commission-based), which can vary significantly from one type of investment product to the other. (Some products, such as annuities, carry commissions as high as 8 to 10 percent.)
Also, under the suitability standard, there isn’t any obligation to disclose a conflict of interest, although many are often very up-front and honest about their sales commissions (even if they’re somewhere in the “fine print”). And even if they do disclose them, they are under no obligation to do anything about it. That means that sometimes the products are best for the agent/broker precisely because they are high cost to the investor.
So why all the fuss?
I want to remind you of a simple truth: Financial services companies exist for one main reason: to make money. Is that wrong? Of course it isn’t. If those companies and the professionals they employ couldn’t make any money, well, they probably wouldn’t exist. Then we would all be on our own, which wouldn’t be a good situation either.
In one sense, most financial professionals are basically sales people – they want to sell you a product or a service. Typically the product is a mutual fund, an insurance policy, or an annuity. Or, it could be a financial plan or managing and investing your assets for a fee, typically a percentage of the amount under management. It could even be an hourly fee for advice only.
Just to be clear, I am not suggesting that this is somehow wrong or unethical. Just because they sell you something doesn’t mean they don’t give good advice. Nor does it mean that they are all out to take advantage of you. It simply makes sense that in order to make a living they have to sell you an investment product that pays them a commission, or sell you a service for which they can charge a fee, or perhaps both.
The interesting thing about this is that the financial industry and many individuals continue to fight against the fiduciary standard. Even our buddy Dave Ramsey is opposed to it, which has stirred things up on social media. The basic argument, as best I can tell, is that such a law would “limit middle-class access to financial advice”, which roughly means that it could price the average investor out of the market for a financial adviser.
And they are some of the people who need it the most.
Our biggest concerns are reduced access to advice for the lower end of the investor spectrum and higher costs for individuals. (Andy Blocker, executive vice president of public policy and advocacy at the Securities Industry and Financial Markets Association)
Of course, there are others who understand that to mean that advisers will not be able to continue to take big commissions from small investor accounts, in which case advisers may not want to bother with small investors. This could make it more difficult for the average investor to get access to professional advice or investment management services.
Seeking out wise counsel and advice is part of good retirement stewardship
I personally enjoy managing my own investments and I like to encourage and help others to do the same. But I also believe having a good financial adviser/manager is the best course of action for most people. A “good” financial adviser brings a unique mix of skills to the table: He/she needs to have hard technical knowledge, soft empathetic and communication skills, and the proper alignment of interests.
The Bible contains many verses about the benefit of Godly counsel. I think Larry Burkett has a very good perspective on the general principle of seeking wise counsel and advice:
Balance is what God teaches us —the balance between [scripture] verses that say it is a wise person who seeks the counsel of many others and verses that warn if we listen to too many people we will go astray. Somewhere in between is the balance. God wants us to be open, listen to people with the same value systems, but not follow their direction for our lives too closely; rather, use it cautiously —as counsel in finding God’s direction. (Dr Larry Burkett, from the book: The Word on Finances)
Government regulation and standards are appropriate to a point, but each of us has a responsibility do our homework when it comes to choosing a financial adviser. Personal recommendations are great, especially since you are looking for someone you can trust.
There are several different ways that advisers are paid, so it’s vitally important that you understand how they are paid before you do business with them. Generally speaking, my advice is to be careful of advisers who operate on a commission basis, but that doesn’t mean you should avoid them all together.
If your adviser is selling 85 year old widows living off Social Security a portfolio of small cap growth stocks, run away – fast! If you’re a 55 year old and your broker tells you to put all your money into an annuity, do the same.
To be clear, not every broker is trying to do that kind of thing, but certainly there are some out there who should be avoided. Perhaps a broadening of the fiduciary standard will help with the bad apples, but I’m not certain one way or another, as the really bad ones will always find a way.
I believe that financial professionals deserve to be paid for their services. I also believe that they should provide those services in a way that is consistent with their profession’s ethics and standards, and I think that includes an appropriate sense of fiduciary responsibility even if they are not bound by the “fiduciary standard.” My concern is that some financial professionals put their financial interests ahead of their clients, which is in direct conflict with the fiduciary standard.
Choosing an adviser
When you look for a financial planner/adviser, you may be told to look for someone with this or that professional designation. But those letters after their name don’t all have the same value. Certain designations like Registered Investment Advisor (RIA) include a fiduciary standard component, which I believe is a good thing.
But being a fiduciary alone is not enough to find an appropriate advisor, nonetheless it does serve as a very simple and basic filter, and I would suggest that you start there.
From there, the alphabet soup of financial professional designations and certifications can be very confusing. In addition to the RIA designation, it may also be good to look for those with the Certified Financial Planner (CFP), Chartered Financial Consultant (ChFC), or similar designations. (Investopedia has a good list of these various certifications and what they mean. CFP is probably the most well-known.)
Keep in mind that RIA is not an individual designation like a CFP. It means that the adviser, or the firm that the adviser works for (such as a Fidelity or Vanguard), has filed with the state (Department of Corporations) or the federal government (SEC) that they are providing financial advice, usually regarding securities, for a fee. Generally, the individual advisers are required to have taken the comprehensive Series 65 exam, though requirements vary by state, and this can be waived in certain circumstances. They may or may not hold certain professional certifications such as Certified Financial Planner (CFP), Chartered Financial Consultant (ChFC), or Chartered Financial Analyst (CFA), among others.
The other group that you may do business with is Registered Representatives. Like RIA, RR is an individual designation that typically refers to stock brokers who are licensed to sell securities of various kinds, usually for a commission. They are not currently subject to the fiduciary standard, but are obligated to adhere to the “suitability” standard as described earlier. Of course, the current regulations that are under debate could change all that.
Stockbrokers will have at least passed a Series 7 exam, possibly other Series exams and be registered with FINRA, or another self-regulatory organization. They may also hold the CFP designation and combine planning and selling securities. Stockbrokers typically work at large investment firms called broker-dealers that provide them support and oversight.
The bottom line
Regardless of how the politics of this plays out, my recommendation is always to choose a financial advisor who is willing to work with you with the heart of teacher and the role of a fiduciary, even if he or she works on commission. You want to work with someone who makes sure you know what you are buying and why you are buying it, who is fairly compensated, and who will not put their interests ahead of yours. That just makes good sense and good retirement stewardship.
April, 2016 Update:
As expected, on April 10, 2016 the U.S. Department of Labor (DoL) issued its rule that will…
Require more retirement investment advisers to put their client’s best interest first, by expanding the types of retirement investment advice covered by fiduciary protections. (U.S. DOL)
In spite of this, the debate is not likely to be over. There are hardliners on both sides of this issue. The financial adviser industry was generally not in favor and may still not be happy with the current rule. They may challenge it in court. On the other side are people and many politicians who are ideologically opposed to the idea of the government telling any industry how it should conduct itself. They may also try to derail it.
Will the rule be a good or bad thing for individual investors? Time will tell. Until then, I think most financial advisers, from both the broker side and the investment adviser side of the industry, will continue to do what they do. Because, at the end of the day, for the vast majority of them, acting in their clients’ best interest is not something they need to be forced to do. After all, it is the reason that they became advisers in the first place. Find one of those kind of folks to work with you, and you should be just fine.