You probably assume that whomever is managing your money is required to always act in your best interest.
Sadly, that assumption is wrong. If you are working with a big, national firm or even a smaller firm that bills itself as “independent,” but in reality reports to an entity called a broker dealer, then your advisor may not have to put your interests first.
The definition of a fiduciary financial advisor is straightforward: It’s an advisor who has a legal and ethical obligation to put the client’s interests first, at all times. This means not receiving commissions for making trades. It also means not accepting business that benefits the advisor, but not the client. For example, at our firm, we don’t do one-and-done financial planning by the hour, since that type of short-term engagement does the client no good – despite what you may have read in the media.
By that definition, traditional stock brokers and people who do hourly planning cannot hold themselves out as fiduciaries.
Unfortunately for investors, the financial services industry is bewildering and opaque. From the outside, it’s very difficult to sort out who has the obligation to work in your best interest, 100 percent of the time. It doesn’t help that some advisors may hold that duty in some of your accounts, but not all of them.
The situation just got worse and more confusing for investors: On June 21, 2018, the Fifth Circuit Court of Appeals issued an order vacating the Department of Labor’s fiduciary rule. That rule was put in place to assure that advisors adhere to the fiduciary standard when managing qualified retirement vehicles, such as a 401(k), 403(b), 457 or Individual Retirement Account. The fiduciary standard carries the legal obligation to act in a client’s best interest.
Many industry participants, myself included, believed the Department of Labor’s rule did not go far enough. Why only require the fiduciary standard in retirement accounts, but not in other accounts? Why leave that door wide open for shenanigans? I don’t have a good answer for what the folks in Washington may have been thinking when the rule was established in April 2016 (although implementation was never fully enacted). They certainly seemed to leave a gaping hole, adding to investor confusion about the fiduciary standard.
On the plus side, many investors are now at least somewhat familiar with the term “fiduciary.” Unfortunately, advisors who are only fiduciaries some of the time continue to tout that aspect of their business, leaving out the full truth.
Looking out for a client’s best interests means not selling commission-based investment products, which generally results in a conflict of interest. For example, say a very inexpensive index fund is the best alternative for you, but your broker gets no direct compensation for selling you that. But meanwhile, the broker stands to get a nice commission from selling you a more expensive fund. Which do you think is more likely to happen?
As a pure fiduciary, I am not allowed to collect commissions or kickbacks for selling financial products. A fee-only model, which incorporates a full range of planning services, allows advisors to get paid, while avoiding the conflicts inherent in selling mutual funds with embedded commissions and other hidden fees.
With the old system of broker commissions and product sales, the advisor makes the same amount of money regardless of how your investments perform. In contrast, or fee-only firm, which is paid according to a contractually agreed-upon management fee, aligns its interests with yours.
Over the years, our firm has seen plenty of examples of big, national firms doing damage to clients. We have one client whose account was being churned yearly by a well known, name brand firm that advertises on TV and has a huge national presence. The broker would receive direct compensation for the funds he sold to her. After the mandatory one-year holding period, he would sell them all and purchase new funds for which he was also directly compensated.
People often feel comfortable dealing with the big national brands, but examples like this abound. We often see portfolios loaded up with all manner of expensive funds with no apparent underlying investment philosophy. The portfolios are just a bunch of “stuff” with high internal fees.
Do your own due diligence on your portfolio. Ask your advisor for the fact sheet, which will tell you whether your funds contain what’s called a 12b-1 fee. This is a marketing fee that a mutual fund charges you, the investor, so the firm can market the fund to other investors. It also includes various administrative fees. Nice, huh? You’re paying for that directly.
Also ask your advisor whether the funds you own have loads, or sales charges, when you buy or sell. You may be surprised to learn about the hidden fees baked into your accounts.
Although the fiduciary rule is dead – for now – you can absolutely find advisors whose firms are legally obligated to act in your best interest, 100 percent of the time. Ask yourself: Why would I work with somebody who doesn’t have that duty? Why would I work with somebody who might sneak in products that offer him or her a commission of some sort, but may not be the very best thing for my situation?
It pays to ask some questions before signing on the dotted line and not accepting substandard service because you “like” the advisor or think he or she is “a friend.” If you are not working with someone who is obligated to be a fiduciary all the time, you are short-changing yourself.