If you're going skydiving, it helps to know that your instructor has your best interest at heart. You trust that they'll ensure your parachute opens on time and that you land safely on the ground.
Working with a financial advisor may not be life or death, but they do hold the ripcord to your financial future. There's an ethical parachute some financial advisors abide by that helps ensure you stay safely on course: the fiduciary duty.
If you work with a fiduciary financial advisor, it means that they have your best interests at heart — but be careful, because not all advisors do.
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A fiduciary is an individual who acts in the best interest of a particular person or beneficiary. Fiduciary financial advisors must only buy and sell investments that are the best fit for their clients. Fiduciaries have a bond of trust with clients and must avoid conflicts of interest.
If your financial advisor does not have a fiduciary duty to you, they may be able to recommend investments or products that pay them a bigger commission over ones that would be the best fit for you, which could cost you more.
Not all fiduciaries are financial advisors. Fiduciary relationships exist in many places where a high level of trust is required: Board members may have a fiduciary duty to their companies, trustees owe fiduciary duties to their beneficiaries and retirement plan administrators typically have a fiduciary duty to their company’s employees.
Fiduciary duty vs. suitability standard
The Investment Advisers Act of 1940 stated that an investment advisor (or anyone in the business of giving investment advice) has a fiduciary duty to their client. The act itself calls these measures broad and does not provide specific regulations beyond requiring that advisors act in the best interest of a client. Broker-dealers are not uniformly governed by a fiduciary duty, though under particular circumstances (such as state law), some may be held to a fiduciary standard. Instead, broker-dealers must follow a suitability standard set by the Financial Industry Regulatory Authority, or FINRA, which means broker-dealers must have a reasonable belief that an investment, transaction or frequency of transactions is suitable for the customer.
This “reasonable belief” leaves room for broker-dealers to recommend products that will increase their bottom line through commissions but may not necessarily be the best investment for you. Fiduciaries, on the other hand, must act in your best interest. That is why it is better to work with a fiduciary rather than an advisor who is simply following the suitability standard.
How do I know if I'm working with a fiduciary financial advisor?
The legislation surrounding the trustworthiness of financial advisors is murky and essentially puts the responsibility of verifying an advisor’s fiduciary status on the shoulders of the client.
There are many different types of financial advisors, and beyond that, several certifications and licenses those advisors can hold. Few titles beyond investment advisor and broker-dealer are regulated at all, including common titles like “wealth advisor” and “financial advisor.”
One way to ensure your advisor is a fiduciary is to work with a certified financial planner, whose certification requires a fiduciary duty and ensures they have significant financial education and experience. You can verify a CFP through the CFP Board’s website.
Is a robo-advisor a fiduciary?
Robo-advisors use computer algorithms to build and manage an investment portfolio for you based on personal factors, such as risk tolerance. Many robo-advisors are registered as investment advisors with the Securities and Exchange Commission and have a fiduciary duty to their clients. However, critics of robo-advisors often cite their limitations — many robo-advisors have a limited understanding of clients, which may mean they’re unable to help with broad financial planning guidance such as debt management — as enough to disqualify them as fiduciaries.
» Need help investing? Learn about robo-advisors
If you’re looking solely for investment management, many robo-advisors offer that in the capacity of a fiduciary. However, most won’t be able to take your full financial picture into account the way a traditional advisor might.