If you’ve been following the financial news recently, you may have heard the term “fiduciary”. It became a popular buzz word when the U.S. Department of Labor proposed new regulations (called the “Fiduciary Rule”) on investment advisors in April, 2016. After two years of wrangling, the regulations were essentially thrown out and never materialized, but they created quite a stir in the industry.
Simply put, when acting in a fiduciary capacity, an advisor must act exclusively in their client’s best interest, not their own self-interest. When investors first hear of this rule, you can imagine how many react - “What? How is this not already required of financial advisors?”
The reality is that there are two standards financial advisors currently work under – a “fiduciary” standard and a “suitability” standard. A “suitability” standard requires that the recommendations an advisor makes are reasonably appropriate based on their client’s tolerance for risk, needs, and financial circumstances. The recommended product doesn’t have to be the best for them, it just has to be suitable.
To really understand this, we need to understand how advisors get paid. When acting in a fiduciary capacity, advisors are typically paid through fees that they charge their clients – most often a percentage of the assets they manage. These fees are generally easy to calculate and should be disclosed on investment account statements or billed outright to clients. Commission-based advisors get paid sales commissions from the companies that manufacture financial products - often life insurance, annuity, and mutual fund companies - or commissions for placing trades in their clients’ accounts. Estimating these commissions is generally quick and easy for advisors to do, and it’s perfectly legitimate (it’s not rude) for investors to ask to be told, in writing, what those commissions are. And it’s important because if an advisor will make $500 year 1 if you put your money in an index mutual fund, versus $3,500 if you put the same money into an equity-indexed annuity, versus $12,000 if you put it into a cash value life insurance policy, you deserve to know that and understand the conflict of interest before you do it. The lack of transparency in the compensation advisors receive and the expenses that financial products have are a source of much of the mistrust the public rightfully has toward the financial services industry.
While it is important to find an advisor that you feel comfortable with and trust, that’s not enough. Why? Because there are a lot of “advisors” that are also commissioned sales people who are incredibly talented at making people feel comfortable and selling themselves, their ideas, and their products! So, the way an advisor makes you feel has nothing to do with whether there are conflicts of interest in what they recommend. That’s why it’s so important for you to demand to know how and what they will get paid before you implement their recommendations. There’s nothing wrong with commissions - most auto, homeowners, and life insurance policies pay a commission to the salesperson - as long as you understand the financial arrangement. In the same way, there are financial products (like bank CD’s for example), that don’t have “fees”, but that doesn’t mean the banks aren’t making money.
So, if your financial situation is complex enough that you need to hire a financial advisor, how can you tell when an advisor is acting in a fiduciary capacity, and how should you vet prospective advisors?
- Ask your advisor. Have them explain the fees and expenses that you pay so you understand exactly how they are compensated. If they receive commissions, ask them to disclose in writing exactly what they will get paid if you implement a particular recommendation before you do it. It’s generally safe to assume that no one is working for free.
- Look at advisors’ affiliations. Many financial people work under a “doing business as” name that is fairly generic. Look at the bottom of their website or the back of their business card. Are they affiliated with any other companies? Are they aligned with a broker-dealer that is owned by an insurance company or affiliated with a company that manufactures financial products? If so, they may very well get paid commissions for selling those products and be expected to do so.
- Go to brokercheck.finra.org and look them up. If they appear, you will find any history of customer complaints, their firm affiliation, exams they’ve passed, time in the industry, and the states they are licensed in.
- Know that how friendly, good looking, caring, or well-known an advisor is may have nothing to do with how they get paid, or what conflicts of interest they may or may not have.
- Look at their credentials, and learn which ones are most meaningful. Advisors who have the industry’s leading credentials have often spent years studying and are required to have experience prior to using the designation.
Once you’ve done your homework, understand how advisors are compensated, and find one you trust, invest in the relationship. A trusted advisor can have a meaningful impact on your financial security. To get to know Milestone and see if we are the partner you are looking for, check us out here.