Whether you’re brand-new to investing or are decades into saving for retirement, you want to know that the people managing your money are putting your best interests first. In legal terms, that’s called a "fiduciary relationship." A fiduciary is a financial professional legally bound to invest your money without thinking of his or her own gain and without any potential conflicts of interest.
But how do you know if your financial adviser is a fiduciary? Financial professionals go by so many different names nowadays: money managers, wealth advisers, financial planners, investment advisers, brokers, etc. What do those job titles really mean, and which of those fields are regulated to ensure that your money is in safe hands?
We spoke with Dirk Edwards, a CPA (certified public accountant) and financial planner with decades of experience advising clients on aligning their financial resources with what is meaningful and important to them. It turns out that not all investment professionals are fiduciaries, and smart investors need to know which questions to ask before they put just anyone in charge of their financial future.
Why Fiduciaries Matter
After millions of Americans lost everything in the 1929 stock market crash and ensuing Depression, President Franklin D. Roosevelt created the Securities and Exchange Commission (SEC) in 1934 to regulate Wall Street. The Investment Advisers Act of 1940 was the first to classify investment professionals as fiduciaries with the responsibility to put the client’s interests first, act in good faith and disclose all conflicts of interest.
"Being a fiduciary means that you have an obligation to make sure you’re putting your client’s best interest at the forefront of what you do," says Edwards. "If you’re holding assets for a client or group that generally comes with a legal authorization and duty to make decisions on behalf of the other party. The law generally holds a fiduciary to a higher standard than someone who is not in a fiduciary relationship."
Let’s say you ask your brother-in-law to deposit a paycheck for you and he loses it on the way to the bank. You could get mad at your brother-in-law, but you probably couldn’t sue him, because it’s not his fiduciary responsibility to properly deposit your paycheck. But if you own a business and have your clients send payments directly to your CPA, she has a fiduciary responsibility to make sure they get deposited in the right place. Fiduciaries are held to a higher legal standard.
Even with the SEC and state financial regulators, Edwards says that anyone can call themselves a "financial planner" and start charging for financial planning advice. "That doesn’t require any sort of license," he says.
To avoid putting your money in the wrong hands, it’s important to know which types of financial advisers are licensed and which are held to the highest fiduciary standards.
All Registered Investment Advisers Are Fiduciaries
As Edwards said, anyone can post a sign in a storefront and call themselves a "financial planner," but the SEC and state regulators have created a system for registering investment advisers. You can even look people up by name and check if they are registered investment advisers.
Under the Investment Advisers Act, all registered investment professionals are fiduciaries. Their fiduciary responsibilities fall into two major categories:
- Duty of care: To provide advice that is in the best interest of the client and to seek the best execution of the client’s wishes.
- Duty of loyalty: To eliminate any potential conflicts of interest. The adviser must never allow his or her judgment to be influenced, consciously or unconsciously, by anything but the client’s best interest.
As of 2018, there were more than 17,000 smaller investment advisers registered with individual state regulators, and more than 13,000 "large" investment advisers (meaning they manage more than $100 million in assets) registered with the SEC.
Are Broker-Dealers Fiduciaries?
"Broker-dealer" is the official term for a stock brokerage firm like TD Ameritrade or Charles Schwab. Up until very recently, broker-dealers were not required by law to necessarily put their clients’ best interest ahead of the broker’s own desire to make some extra cash. Instead, broker-dealers were held to something called the "suitability" standard. That meant that a broker-dealer was only required to ensure that all investments were "suitable" to the client and their investment strategy. But it allowed broker-dealers to consider their own interests, too, such as offering investment vehicles that earned a potentially higher commission.
But starting in June 2020, the SEC changed the suitability rule to what it calls Regulation Best Interest. Under this new rule, the SEC says that a broker-dealer, like a registered investment adviser, cannot put his or her interests ahead of the customer when recommending specific investments. Broker-dealers also have to file a form with the SEC called a "relationship summary" that fully discloses the broker’s relationship with a brokerage house and how he or she benefits from certain investment instruments.
Does this make broker-dealers fiduciaries? Not exactly. In announcing the rule change, SEC Chairman Jay Clayton said that Regulation Best Interest "draws from key fiduciary principles," while registered investment advisers owe a "federal fiduciary duty" to their clients. The legal standard for investment advisers is still higher than it is for brokers.
"Under the broker-dealer provisions, you can disclose that you’ve got a conflict and still make the transaction," says Edwards. "If you’re a fiduciary and there’s a conflict of interest, you can’t do the activity at all."
What About Certified Financial Planners?
Certified Financial Planner, or CFP, is an industry designation for financial professionals who have met certain educational and ethical standards set by the certifying organization. In 2019, there were 86,000 CFPs in the U.S. But as Edwards explains, there’s no government regulatory agency or licensing board behind CFP.
"If there’s an issue, they can take away your CFP certification, but there’s no regulatory impact," says Edwards.
It should be said that according to the CFP code of ethics and standards of conduct, CFPs "must act as a fiduciary," including both the duties of care and loyalty expected of registered investment advisers. However, this does not apply in all circumstances. If a CFP fails to uphold those standards, they are only subject to discipline by the membership organization, including losing their trademark designation.
Edwards points out that it’s different for CPAs like himself. CPAs are actually licensed and regulated by their state. So, if a CPA breaches the American Institute of CPAs’ Code of Professional Conduct, it could result in the loss of their CPA license, which would bar them from practicing, including representing clients before the Internal Revenue Service.
Questions to Ask a Financial Adviser
Shopping for a financial adviser can be daunting and confusing, so Edwards recommends that all new investors arm themselves with a series of simple questions to determine whether an adviser will always put your best interests first.
1. What type of advice are you going to give me?
The "right" answer to this question depends on your specific financial situation and investment goals. If you’re just starting out and want to put some extra money away, the options available are fairly straightforward. But if you have significant money to invest and are open to riskier options, you’ll want someone who can make personalized recommendations to match your needs and setting. You’ll always want an adviser who is fully on your team.
2. How do you get paid?
This is one of the most important questions to ask a potential financial adviser. If the adviser is a fiduciary, then all of her income should come directly from her clients. Again, not every investor needs to hire a registered investment adviser, but if that fiduciary relationship is important to you, then the adviser should disclose if she receives commissions from making trades or from selling certain investment instruments.
Traditionally, investment advisers for large portfolios would get paid 1 percent of the assets under management, but Edwards encourages his clients to evaluate the total cost versus its value. Some advisers charge by the hour or on a "fee-only" basis, meaning they charge a flat fee for their services, rather than on a trade or commission basis.
3. Will you provide me with an investment policy statement?
Edwards says that an investment adviser should provide all clients with a written investment policy statement. This document functions like a personalized road map for the investor. It outlines the individual’s investment goals, their risk tolerance, their asset allocation and benchmarks for evaluating whether the investment strategy is working. This investment policy statement should be revisited regularly, and as the investor enters different life stages or changes investment goals.
4. Are you legally bound to always act in my best interest?
That question really lays it on the line. If you only want to work with a fiduciary, then find someone who is a registered investment adviser and is legally obligated to not only put your financial interest ahead of his but to advise you against making decisions that will hurt your own financial future.
Now That’s Interesting
Fiduciaries are found in other business relationships as well. For instance, a trustee should be a fiduciary to a beneficiary (in a will or an estate situation); corporate board members should be fiduciaries to shareholders; and attorneys should be fiduciaries to clients. In all these cases, fiduciaries are legally required to put their clients’ interests above their own.