What is a fiduciary?

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A fiduciary is someone who acts in the best interests of others. In the case of a financial advisor, the National Association of Personal Financial Advisors (NAPFA) specifies that a fiduciary should always act in the best interests of their clients. Further, a fiduciary should be proactive in disclosing any conflicts of interest that might impact their clients.

What is a fiduciary?

In general, a fiduciary is a person or organization that acts on behalf of another person or organization, and it involves putting their client’s interest ahead of their own. A fiduciary is more than just a financial advisor or other type of advisor, however, because of the high duty of care. So, not all financial advisors are fiduciaries, though some advisors may obscure this fact.

Attorneys, trust officers and financial advisors are among the professionals who may be required to act in a fiduciary capacity. NAPFA is a leading organization of fee-only financial advisors that requires its members to adhere to a fiduciary standard. Advisors who hold the certified financial planner (CFP) designation are also required to act as fiduciaries.

Fiduciary duty vs. suitability standard

Financial advisors are typically held to one of two types of standards when it comes to advising clients: a fiduciary standard or a suitability standard. The differences between the two reveal the differing levels of care that an advisor must show to clients.

As financial advisor industry expert Michael Kitces has said, “Suitability means selling a suit that fits you. Fiduciary duty means that it has to look good on you, too.”

Suitability means that a financial product is suitable or may be a good fit for somebody in your general situation. This might be defined as someone who is the same age and marital status as you are, and whose income is roughly similar to yours. But an investment or financial product that is suitable may not be appropriate for your unique situation.

In contrast, an advisor adhering to their fiduciary duty to a client takes this a step further and does due diligence to help ensure that any investment vehicle or financial product is appropriate for their client’s unique financial situation. This takes into consideration their client’s goals, risk tolerance and other investments, among other relevant factors. Even the best robo-advisors attempt to tailor their portfolios to your needs by asking relevant questions.

In choosing a financial advisor to handle your unique financial situation, you should decide if someone who gives generalized recommendations that may be appropriate for your broad situation is what you’re looking for, or if you want an advisor who takes their duty of care seriously and tailors their financial advice to your needs.

In other words, is a suit that just fits all right, or do you want one that looks good on you?

What is the difference between a fiduciary and a financial advisor?

Essentially, someone can be a financial advisor but not be a fiduciary, and it’s important for potential clients to know the differences. Here are some key distinctions.

Investment advisors registered with the U.S. Securities and Exchange Commission (SEC), as well as with many states, have a fiduciary duty to their clients. They are obligated to put the interests of their clients first and to disclose any conflicts of interest that could influence the advice they give.

In contrast, many advisors working through broker-dealers may not be held to a fiduciary standard, but rather to the less stringent Regulation Best Interest standard, or Reg BI, as set forth by the SEC. This regulation imposes a standard of care on broker-dealers, but has only some components of the fiduciary standard, including the duty to disclose potential conflicts of interest that could influence the advice they provide to clients.

But still other financial advisors may not even have that lower standard of care. So it’s vital that consumers understand what standard a potential advisor works under, if any, and what obligations they have to their clients.

What are the potential legal consequences for breaches of fiduciary duties?

Breaches of fiduciary duty are serious matters with potentially serious legal consequences. If a fiduciary breaches their duty, the victim can file a lawsuit and potentially receive compensatory damages as a remedy. Compensatory damages are intended to return the victim to the position they were in before the breach. Courts may also award punitive damages. Punitive damages may be awarded when the fiduciary’s actions were intentional, egregious or malicious.

In some instances, breaches of fiduciary duty may result in criminal charges, which could lead to jail time, depending on the charges. An advisor can only be jailed if they’re convicted of criminal charges.

Why it’s so important to work with a fiduciary financial advisor

While every investor should do what they feel is best for them, working with a financial advisor who is a fiduciary is a wise decision. At a basic level, why would you want to work with an advisor who does not have an obligation to act in your best interests?

In choosing a financial advisor, you’ll want to ask a number of important questions.

• “How are you compensated?” Ideally, you should seek out advisors who are fee-only. This means that all compensation they receive is paid by their clients, not by the providers of investment and financial products. Financial advisors are human, and they can be tempted to sell clients financial products that offer the highest compensation to them, whether or not these products are the best choices for their clients.
• “Are you a fiduciary? If yes, will you put this in writing?” Any advisor who is truly a fiduciary advisor will gladly do this, often without you needing to ask. If an advisor claims to be a fiduciary but is hesitant to put that status in writing, that should be considered a huge red flag.
• “Are there any conflicts of interest that you have that would preclude you from providing advice that is totally in my best interest?” A conflict of interest could be that the advisor’s firm may require certain types of investment products for clients.

To be clear, determining whether a financial advisor is a fiduciary is only a step in the process of choosing the best financial advisor for your situation. Many excellent advisors who are not fiduciaries care deeply about their clients and do an outstanding job. Similarly, some advisors who are fiduciaries may lack the knowledge and experience in dealing with clients in your specific financial situation.

Those looking for the expertise of a financial advisor should use Bankrate’s financial advisor matching tool to find an expert in their area.

Determining whether a potential advisor is a fiduciary is an important step in the process of choosing a financial advisor. A good analogy to think about here: Would you knowingly use a doctor who only prescribes medications where they receive a kickback from the manufacturer regardless of what the actual best medication might be for your condition? Of course not. The same principle applies in choosing a financial advisor. All else being equal, you should lean toward using a financial advisor who is a fiduciary.