Many people rely on financial advisors to help create a plan to meet short-term and long-term goals. This makes sense. After all, when you need a broken toilet fixed, you call a plumber. If you are feeling sick, you go to the doctor. Unfortunately, there is a bit of mistrust in the financial services industry. In fact, in a 2016 poll by the American Association of Individual Investors, 65% of respondents said they mistrust the financial services industry to some degree. Some of this criticism is completely warranted. Because of this reality, more people are questioning whether their financial advisor is a “fiduciary”. In simple terms, whether or not their financial advisor is putting your interests before their own.
Obviously, every financial advisor should hold themselves out as a fiduciary and put their clients’ interests first. This is not up for debate. However, I strongly disagree that a financial advisor being a fiduciary, at least in the strict legal sense, means that you are always receiving the best comprehensive service for your financial situation.
In order to understand this argument, we need to define the main three types of financial advisors.
Broker (Commission Only):
A broker is a financial advisor that works for a broker/dealer and/or an insurance firm. Brokers are paid a commission for selling products to their clients. Note, a commission means that brokers are paid by the product company instead of directly from you. Note, 90% of all financial advisors (est. 280,000) in the U.S. are brokers.
Technically, brokers do not have to meet a fiduciary standard. By law, brokers only have to adhere to a suitability requirement. For example, a broker may legally recommend one product over another similar product if it pays out a larger commission.
Registered Investment Advisors (Fee Only):
A Registered Investment Advisor (RIA) is an advisor that is paid for advice directly from the client. This could mean that the advisor charges a fee based on the percentage of assets under management, retainer fee, hourly fee, or other fee arrangement that is not based on a product sale. About 10% of all financial advisors are associated with RIA firms (est. 31,000) and 1.6% of all financial advisors are only associated with RIA firms (est. 5,000).
RIA financial advisors are held to a fiduciary standard under the law. Therefore, they cannot accept commissions of any kind if they are only associated with an RIA.
Dual Registered Advisors (Fee Based and Commission):
A dual registered financial advisor is associated with both a broker/dealer and RIA firm. This allows them to sell products for a commission or charge a fee for advice. About 8.4% of all financial advisors fit this category (est. 26,000).
When dual registered advisors charge a fee for advice, they are held to a fiduciary standard. However, when they are earning a commission on certain products, they are only held to a suitability standard.
Are you saying I can only trust 1.6% of all Financial Advisors?
Understandably, at this point in the article, you may think that I believe you can only trust 1.6% of all financial advisors. However, in my experience, many financial advisors do put their client’s interests first regardless of the way they are compensated. As a dual registered financial advisor myself, I have a unique perspective to this debate. It is much more complicated than the media or the average financial advisor discloses.
Consider the Following Points…
Compensation Structures Matter
As discussed in a previous article, certain compensation structures are more appropriate for different types of clients with different goals. Therefore, in my opinion, financial advisors who are only brokers or only associated with an RIA firm are at a disadvantage for being able to serve clients with unique needs. For example, an advisor who is only a broker cannot be paid for comprehensive advice. Also, an advisor who is only RIA affiliated cannot sell certain types of products on commission (insurance, annuities, 529 plans, etc.) when there might be a real need. I believe that if a client is seeking comprehensive advice, they might expect their advisor to be able to manage everything.
Fee Only ≠ Inexpensive
Working with certain types of fee only fiduciary advisors might be expensive. For example, the XY Planning Network is an organization of fee only financial advisors that primarily work with members of Generation X and Generation Y. These financial advisors use unique payment structures to serve this demographic. Many of their members charge a combination of an upfront fee for a physical financial plan, ongoing monthly retainer based on assets or net worth, and investment fees.
For example, pretend a potential client wants to invest a $100,000 with one of their affiliated advisors. Assume the advisor charges $1,000 for a comprehensive financial plan. Additionally, they charge a $150 monthly retainer. On top of that, if you decide to invest with them, they charge a 1% assets under management fee. When you combine these costs, it is equal to a 3.8% assets under management fee in the first year and 2.8% assets under management fee in later years. In my opinion, this compensation structure is very expensive for the average household.
No Conflict of Interest
There is no such thing as conflict free advice. Any payment structure in any industry has some sort of conflict of interest. For example, a financial advisor charging a commission may want to change mutual funds often to be able to charge you an up-front fee. Whereas, a financial advisor who charges a fee based on the assets under management may place an investor’s funds in an account for no reason other than to collect a fee. Ultimately, it comes down to what makes the most sense for you.
Fiduciary Future Outlook
Although the DOL Fiduciary Rule was overturn by the 5th Circuit Court, which would have made brokers fiduciaries on retirement accounts, it is clear that brokers will eventually have to hold themselves out to a higher standard than suitability. In fact, the Securities Exchange Commission (SEC) is working on enhancing these standards for all financial advisors. Due to the public opinion of financial advisors, these enhancements seem inevitable in the coming years. Thus, in my opinion, it will eventually make the fiduciary question a moot point.
Therefore, only considering a financial advisors’ full-time fiduciary status is not always the best way to decide if you should work with them. Even if all financial advisors are fiduciaries in the future, there will always be other factors that people must contemplate before choosing an advisor. Ultimately, no regulation will ever absolve you of doing the research to find the proper match.
If you are looking for comprehensive financial advice, the following are some better ways, in my opinion, you can discover the right financial advisor for you.
Work with a CERTIFIED FINANCIAL PLANNER™ Professional (CFP®)
Note that CFP® professionals who provide financial planning services are held to the duty of care of a fiduciary defined by CFP Board. This fiduciary duty exists regardless of compensation structure. Additionally, CFP® practitioners must participate in continuing education.
Avoid Financial Advisors who are only Brokers or Insurance Agents
Although brokers and insurance agents can sell products that may complement a comprehensive financial plan, they typically do not have the tools to provide services that are indicative of comprehensive financial advice. If you are only looking for a specific product, brokers and insurance agents may be appropriate.
Understand that Fee Only Financial Advisors are not Conflict of Interest Free
Although these financial advisors are legally fiduciaries at all times, they are unable to sell products with a commission even if it is in the client’s best interest. They may have to refer to a third party to help you implement parts of your financial plan. In practice, working with a third party could create a different conflict of interest.
For example, as a CFP® professional, I know that the implementation phase of a financial plan is extremely important. Since I am a dual registered financial advisor, if a client has an insurance need, I am able to control the process to make sure it gets properly implemented. If I refer out to a third party, it is possible that a client might be sold more products than is necessary or never implement the plan at all.
Ask your Financial Advisor Thought-Provoking Questions
Firm Size Matters
Larger established firms such as Merrill Lynch, Morgan Stanley, UBS have high account minimums for clients who wish to receive comprehensive financial planning. It is worth noting that some of these firms do have lower minimum offerings. However, smaller clients are typically segmented and do not receive the same level of service as high net worth individuals. On the other side of the spectrum, smaller boutique firms such as XY Planning Network have no account minimums. However, depending on the size of your accounts, you may be spending more for a financial advisor than needed.
Smaller firms that are already established might be willing to work with clients with fewer assets without charging an arm and a leg. This step may require a bit of research on your part.