Part 2: A Great Financial Advisor is a Fiduciary

  • May 30, 2018


    Registered investment advisors are legally classified as fiduciaries – meaning they have a duty to their clients to serve the client’s best interests. Many other investment professionals – such as brokers – do not have a fiduciary duty and can place clients into products that offer higher profits to the broker and lower profits to the client.

    For example, suppose you are in need of a mortgage to refinance or to purchase a new property. A fiduciary has the responsibility to provide you with advice which best serves your interests. A non-fiduciary investment professional might be required by his or her employer to urge you to use the firm’s mortgage services, even if the mortgages are more expensive than those available elsewhere. It makes sense that most firms that are fiduciaries provide advice that focuses on the client’s needs rather than the firm’s profits. Fiduciaries are required to advise you if you can find a better mortgage at another firm. Investors should seek firms that search for the best deals for their clients, rather than deal with firms with employees who are strong-armed into pushing in-house products.

    As another example, many mutual funds have different classes through which investors can access the same fund. Generally speaking, the fund class that is best for the client is often the class that offers the lowest total commissions to the sales person (e.g., broker). The salesperson may justify the expensive mutual fund claiming that if the investor holds the mutual fund long enough, the long-run fees will be relatively minor.

    But here is what happens all too often:

    Step #1: An investor buys a fund or other product with enormous fees and commissions based on the “free” advice of a broker or other sales person.

    Step #2: The fund performs relatively poorly because of the fees and commissions. Fund managers that have offered salespeople the highest commissions tend to have the highest underlying conflicts and costs as well.

    Step #3:  Eventually, the fund ekes out a profit and the frustrated investors seeks more “free” advice from the same salesperson or a new salesperson about a fund that might do better.

    Step #4: Repeat the insanity by returning to Step #1.

    There is a better way. As painful as it may seem, offer an honest investment professional explicit fees such as 0.80% of the portfolio’s value annually as a management fee, or maybe $100 per hour for a financial planner’s time. Be sure to confirm in writing that the professional is not receiving any commissions or other compensation from the relationship. In the long-run, you will likely pay far less in total expenses, and you will be better served because your professional has no incentive to recommend anything other than the actions that are best for you. That is what a fiduciary is charged with doing.

    Ask your chosen professional whether law requires them to satisfy fiduciary obligations in their management of your money.

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