You may not be sure what a fiduciary is and why it’s so important. Let me assure you that this is a crucial concept to understand. In fact, if you get professional financial advice from anyone, this one word can mean the difference between success and failure. Let me explain why I feel so strongly about this with an analogy.
Assume your daughter needs to get her tonsils taken out and you have to choose between two doctors. One works for you (a “health fiduciary”) and the other is employed by a pharmaceutical company. Which one do you want operating on your child? Of course the answer is clear. You want the one who works for you because you want the best possible outcome for your daughter.
In the real world you don’t have to make this choice. If a doctor treats patients but does what’s best for the drug makers, the doctor goes to jail. I wish I could say the same thing about financial service providers but I can’t.
I’m sad to report that brokerage firms and insurance companies get away with telling people they are “operating” with the clients’ best interests at heart when in fact they are not. They get away with this because they do not have a fiduciary responsibility towards clients. So this is very misleading, it has dire consequences but it’s not illegal. That’s why I want to discuss this with you now.
What is a fiduciary?
A fiduciary is a person who has a legal obligation to put your interests above their own. If they fail to live up to this standard, they can be sued or prosecuted or both.
If you noticed, I used the word “obligation”. I didn’t just throw that in to impress you with my ability to use 4 syllable words. “Obligation” is the key to understanding what “fiduciary” means and why it is at the epicenter of your financial future if you work with a financial advisor.
How Critical “Obligation” Is
There are times when we have to rely on other people. We have no choice because they have expertise that we need but do not have. When we take that leap of faith, it’s nice to know the people we are working with are obligated to put us at the front of the line. Working with someone who is OBLIGATED to do that gives me warm tingles. You too…right?
Are All Financial Advisors Fiduciaries?
Not by a long shot. And even the ones who say they are sometimes aren’t (more on that shortly). I talked about this at length in my series on financial advisors.
Anyone who works on commission is by definition not a fiduciary. That doesn’t mean they are Public Enemy #1. It doesn’t mean they are mean or nasty or liars or cheaters. It doesn’t mean they are unkind to their mothers. It just means they don’t work for you even if you think they do.
Commission salespeople are paid by a brokerage or insurance company to sell that company’s “schlock” and that means they are employees or contractors for that company. They have to put the interests of those firms first or they will get fired.
According to a recent survey by Consumer Federation of America, AARP and North American Securities Administrators Association, 76% of us think that stock brokers and advisors who work at brokerage firms have to put the client’s needs first. I’m sorry to say this but that’s wrong. Stock brokers have to put the interests of the firm they work for first.
The same study said that a third of us think that a stock broker’s job is to give financial advice. I’m even more sorry to tell you that this is double wrong. People think that salespeople are fiduciary advisors because they’ve been misinformed by the industry. Let’s right that wrong together.
The Real Job Of A Stock Broker/Insurance Agent
The insurance agent and stock broker’s job is to sell you something you’ll buy and they have no fiduciary responsibility to you. It doesn’t mean that everything they sell is bad or dangerous. It just means that their intention is to make a commission first and to help you second.
The reality is that agents and brokers are only obligated to sell you “suitable investments”. That’s like the doctor who has to give you a decent drug – not the best one. A fiduciary, as I said at the start of this, has a fiduciary obligation to put your interests first. These are far different standards.
What really boils my broccoli is that while both salespeople and fiduciaries talk to you about the same areas of your financial life, one has to put you first while the other doesn’t. And believe it or not, it actually gets a little worse.
Brokers sometimes get special incentives to sell certain insurance or investments without even telling you. That’s right. They sometimes cash in and get bling and swag like TV sets and trips to far off exotic destinations if they convince you to buy certain investments. Do you want your doctor getting tickets to the theatre if she prescribes one medication over another? Of course not. Why should an advisor be able to sneak this through? The answer is….they should not.
Are Fee Based Planners Fiduciaries?
If you pay an advisor by the hour or on a fee basis, they might be fiduciaries but they may not be. Let me give you a real-life example to explain this a little better.
Most of what I do with clients is fee-based but I also sell life insurance. When I put my life insurance salesman hat on, I no longer function as a pure fiduciary because I earn a commission. Of course I must disclose this conflict.
The point is that once I cross over from advisor to salesman my client has to hope I am being honest and fair. That’s all they have. But when I provide financial advice and money management, they have my promise and obligation. The client doesn’t have to rely on my moral fiber. Esta Bien!
Are All Fiduciaries Trustworthy, Loyal and Brave?
I gave you an example where a fiduciary can also act as a non-fiduciary. Again, the rules require full disclosure when this happens. But not all people who are fiduciaries on paper are Boy Scouts. There are rotten doctors, lawyers and Indian chiefs and there are bad apples in the financial fiduciary barrel as well. Just because someone is legally obligated to put your interests first doesn’t mean they are honest or well-intentioned. Please don’t turn a blind eye. If you do, you just might end up getting poked.
And even if your fiduciary is honest and responsible, it doesn’t mean he or she is smart or skilled. The bottom line is that working with a fiduciary is a good starting point for most people who are looking for an advisor. But just because someone says they are a fiduciary it doesn’t mean you have all the information you need to make a good hiring decision.
If you use an advisor, do you care if they are a fiduciary or not? Have you had experiences with both kinds? What were they?