When you’re looking for someone to guide you through the world of personal finance, there is a lot of jargon you have to work through. Financial advisors and fiduciaries are just two of the titles you’re likely to come across, but they are two of the most important and sometimes misunderstood. Here’s a guide that breaks down the details and how each title applies to the world of financial advice.
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What Is a Fiduciary?
Legally speaking, a fiduciary is someone who acts in the best interest of someone else. Fiduciaries have a bond of trust with another person (called the beneficiary or principal) and have a legal obligation to act for the beneficiary’s benefit and not their own.
In the context of financial services this distinction is important, as the terms used in financial jargon can often prove confusing. Banks, financial firms and individuals can all serve as fiduciaries, but not every service or person is bound by law to represent your best interest.
Common examples of fiduciaries are: trustees, corporate officers, attorneys, and real estate agents. Certified Financial Planners (CFPs) are fiduciaries, as are Chartered Financial Analysts (CFAs). In all cases fiduciaries have a contractual relationship with their beneficiaries that require high levels of trust and good faith, and as a result, must avoid conflicts of interest.
It’s just as important to know who isn’t a fiduciary. Insurance agents, for instance, generally are not fiduciaries. They only have to sell you a suitable product, not necessarily the one that is in your best interest. Because insurance agents work on commission, they may in fact have monetary motivation to sell you a product that is not the best one for you if it brings them a bigger pay day.
What Is a Financial Advisor?
Financial advisors are people and services that help you create a plan for meeting your financial goals and manage it along the way. With the help of a financial advisor, you could save more, invest more wisely and reduce your debt in ways that might not have been possible if you did it on your own.
The term “financial advisor” describes a variety of people and services, including investment managers, financial consultants, financial planners and even digital investment management services called robo-advisors.
However, while financial advisors do generally have more knowledge than laymen about the financial services industry, they are not always legally liable for your money like you might assume. Certain relationships impose fiduciary duties, creating a legal responsibility for the beneficiary, but laws governing these duties are complex. “Financial advisor” is a job title and does not imply a fiduciary relationship.
Are All Financial Advisors Fiduciaries?
A fiduciary is someone who has an obligation to act in your best interest. A financial advisor is a job title that anyone advising about your finances can use. If you’re in the market for a financial advisor, you should strongly consider a financial advisor who is a fiduciary or a fiduciary financial advisor.
In real terms, if a financial advisor does not have a fiduciary duty towards you as beneficiary, that advisor may recommend investments or products that pay them a higher commission instead of ones that would best fit your circumstances–potentially costing you more. You could pay more in up-front fees, your investments might not be a proper fit for your financial plans and in the end, the amount that you earn and save over your lifetime could be drastically different.
How Can You Be Sure a Financial Advisor is a Fiduciary?
Because the laws governing the financial services industry are complex and specific, there are only a few ways in which you can be sure your financial advisor is a fiduciary.
First, you could simply ask. Most advisors will respond candidly if they are fiduciaries or not.
Second, you could verify if your financial advisor is certified or registered with certain groups or governing bodies.
A Registered Investment Advisor (RIA) is registered with the Securities and Exchange Commission or a state bureau and effectively has a fiduciary relationship with clients. All RIA conflicts of interest and outside business activities will be listed on their Form ADV.
A Certified Financial Planner (CFP) is a professional certified by the CFP Board who has passed extensive training and exams. CFPs are held to stringent standards and must uphold their fiduciary relationship with financial-planning clients.
A Chartered Financial Analyst (CFA) is another professional who has undertaken extensive training in investment management. Charterholders are also held to an ethical code that imposes a fiduciary relationship between the CFA and investment management clients.
Lastly, a financial advisor affiliated with NAPFA, the National Association of Personal Financial Advisors, must be a fee-only, fiduciary. An advisor may often be NAPFA-affiliated and hold other credentials listed above.
Bottom Line
Fiduciaries are obliged to act in your best interest, whereas the title “financial advisor” implies no legal obligation. When looking for a financial advisor to help you develop your custom financial plan, you should ensure that your financial advisor is a fiduciary.
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