Find the Best Financial Advisor Part II: Fiduciary
If you missed Part I of the series, you can find the post here.
In the medical profession, physicians practice according to a common standard: “First do no harm.” There should be a similar level of commitment for anyone who wants to advise you about your financial well-being. Unfortunately, there isn't. Financial advice is subject to a double legal standard: “fiduciary” versus “suitable” advice. Worse, it’s up to you to spot the differences between them, and to heed the quality of the advice accordingly.
Fiduciary vs. Suitable: Different Incentives Drive Different Advice
Let’s begin with an analogy. This classic HighTower animated video compares fiduciary versus suitable advice to similar differences between a registered dietitian versus “Lou the Butcher.”
Lou can offer suitable information about quality cuts and prices as you purchase his wares. Still, you wouldn’t ask a meat vendor whether he’d recommend steak or eggplant. Because of his business interests, you already know what his answer will be. A dietitian, in contrast, is paid to advise you on your overall diet according to your personal health goals. His or her livelihood depends on improving your well-being, rather than promoting one product over another.
Similar differences exist between a suitable broker versus a fiduciary advisor. Both may recommend investments, but underlying interests could influence a broker’s suitable advice in promoting one product over another. Fiduciary advice, in contrast, must be based exclusively on advancing your highest financial interests.
Fiduciary vs. Suitable: What’s the Difference?
Why the different legal standards? Government regulators assume that a broker’s primary role is to place trades, so any advice he or she offers is considered secondary to this primary, transactional business. A broker’s advice must be suitable for you, but it does not have to be best for you.
Also, a broker does not have to reveal if a conflicting incentive is driving the recommendation. In his Washington Post column, “Find a financial advisor who will put your interests first,” Barry Ritholtz describes suitable advice in blunt terms: “The suitability standard is far more complicated – and offers much less protection to investors. The simplest way to describe this standard is ‘Don’t sell AliBaba IPO to Grandma.’”
Let’s provide an example of how suitable and fiduciary advice can differ from one another. Imagine you are comparing two mutual funds that are equally appropriate for your portfolio, except one entails higher fees and pays higher commissions to the trader. Brokers offering suitable advice can freely recommend funds that compensate them more handsomely at your expense, without disclosing this fact to you.
On the other hand, if all else is equal between two investment selections, a fiduciary financial advisor must recommend the lower-cost investment that represents your best interest.
Suitable Illustrations in Action (or Inaction)
You may wonder whether suitable conflicts of interest matter. If you’re working with a financial pro and your investments seem to be doing okay, is there any harm done if the broker receives a few extra dollars along the way?
We believe that the investment damage done can be considerably more significant than most people realize. Take this illustration of a couple in their 70s, the Toffels, featured in a New York Times exposé, “Before the Advice, Check Out the Adviser.”
The Toffels were not sold an AliBaba IPO for their $650,000 life savings, but their broker did saddle them with a variable annuity that cost more than 4 percent annually. “That’s more than $26,000, annually – enough to buy a new Honda sedan every year,” observed the columnist. The annuity also included a 7 percent surrender charge, effectively trapping the Toffels into the overpriced holding. Consider this in the context of a typical, no-frills index fund costing less than 0.25 percent, with no surrender charge.
The article points out: “Like many consumers, [the Toffels] say they didn’t realize that their broker wasn’t required to follow the most stringent requirement for financial professionals, known as the fiduciary standard.”
Not yet convinced? In February 2015, the White House weighed in on the subject with its report, “The Effects of Conflicted Investment Advice on Retirement Savings.” Citing evidence from more than 50 independent resources, including dozens of peer-reviewed academic studies, the report estimated that retirement investors might be losing an aggregate of $8–$17 billion each year from conflicted advice. “Conflicted payments are payments to the adviser that depend on actions taken by the advisee,” explains the report, and lists an abundance of such practices, including revenue-sharing, 12b-1 sales fees, front-end and back-end sales loads, commissions on products sold, and additional incentives for recommending one product over another. And of course, such typical cost leaks are by no means limited to retirement savings.
Combine the White House report with The New York Times piece (and many other examples we could cite), and the illustrations draw a clear conclusion: Suitable “advice” costs plenty of families plenty of wealth that would otherwise be theirs to keep. That is why it behooves you to turn to a fiduciary investment advisor whose legal duty is to always advise you strictly according to your highest financial interests, ahead of any such conflicts of interest.
Fiduciary vs. Suitable: How Do You Know?
We believe investors deserve better than advice that is merely suitable for their life’s savings. That’s why we have established RCS Financial Planning as a fee-only Registered Investment Advisor firm, which commits us to always and exclusively be fiduciary financial advisors to our clients. By law and design, we place our clients’ financial well-being at the very top of our decision-making tree, even ahead of our business interests.
Unfortunately, unlike in the food industry where it’s easy to differentiate a vendor from a healthcare professional, it’s often unclear in the financial world just who you’re dealing with, where their interests lie, and what kind of advice you’re receiving. In our next article, we’ll offer some pointers on how to ensure your advisor is a fiduciary, always looking out for your best interests.