Chances are you have used a fiduciary at some time, and chances are you've been a fiduciary to someone else as well. Whether or not you can define the term, the fiduciary plays a critical role in finance and in life.
A fiduciary, in any context, is a person who is ethically or legally obliged to act in the best interests of another party. A doctor or an accountant takes on a fiduciary role. A fiduciary investment adviser is required to choose investments regardless of their own self-interest or the interest of any other party.
An investment advisor who is not a fiduciary follows a less-stringent code requiring only that investments be suitable to the client.
Key Takeaways
- A fiduciary has an obligation to act in the best interests of another party.
- A fiduciary investment adviser is obligated to choose investment products that are in the best interests of the client regardless of self-interest or a third party's interests.
- Registered investment advisers (RIAs) have a fiduciary duty to clients while broker-dealers must meet the less-stringent standard of suitability to the client's needs.
- Fiduciary law is complex, and it can take a blatant misdeed to prove a breach of trust.
What Is a Fiduciary?
A fiduciary relationship involves two parties: the fiduciary and the client. Fiduciaries commit to putting the client's needs in front of their own. This is considered the highest standard of care under the law.
In practical terms, it often comes down to who's paying whom. An investment adviser may receive a commission for selling certain investment products, raising a potential conflict of interest between the client's interest and the adviser's own interest.
Unfortunately, fiduciaries do not always meet the high standard they are supposed to. In addition, there are specific risks to consider when entering into a fiduciary-client relationship. Here are five factors to consider to protect yourself and your assets.
Misconception #1: Everybody Is a Fiduciary
There are two standards of care that apply to money managers: the fiduciary standard and the suitability standard. The fiduciary standard requires the professional to act in the best interests of the client. The suitability standard requires only that a financial advisor make recommendations that are suitable for the needs of the client, even if they are not the best choice for the client's needs.
The fiduciary relationship may be defined by law. For example, a court that appoints an executor to an estate may mandate that the executor do the job to a fiduciary standard.
In other cases, the fiduciary duty is a professional commitment. For example, a certified financial planner (CFP) is bound to the fiduciary standard by the Code of Conduct of the National Association of Personal Financial Advisors (NAPFA).
Misconception #2: There Is Always a Test or License
Fiduciaries gain the designation by actions, not education. Some fiduciaries are chartered financial analysts (CFA) who went through a grueling process to gain the certification. Others may have taken a test to become registered investment advisers.
Some take on a fiduciary role for a single purpose. A fiduciary can be hired by a company that needs an independent third party to oversee a process or plan. Volunteers for the investment committee of a non-profit agree to act in the best interest of the organization.
3(16) Plan Administrators
A 3(16) fiduciary is a service provider hired by a company to administer its retirement plan. The plan administrator follows a set of duties to ensure that the plan is in compliance with regulatory guidelines.
Misconception #3: Fiduciary Law Is Easy to Enforce
Fiduciaries who breach their duty may face tough civil and criminal penalties. It can be difficult, however, to prove a breach of duty in court.
Moreover, they can do their duty towards their clients and still lose money for the client.
For example, imagine you ask your financial adviser to shelter your portfolio from risk even at the expense of sacrificing potential profit. The adviser puts some of the money into blue-chip stocks, which promptly crash in value.
In this case, the adviser has not acted in bad faith. You would have to prove that they acted maliciously and in the interest of some other party in order to prove a breach of fiduciary duty.
Misconception #4: A Fiduciary Guarantees a Profit or Protection from Losses
Under industry rules, no financial adviser can guarantee that you will profit from any investment. If you don't see the results you were hoping for, that doesn't mean that your adviser breached a fiduciary duty.
Hiring a fiduciary is not a guarantee against an unfavorable outcome. You can still experience investment losses when a fiduciary is managing your portfolio.
ERISA
The Employee Retirement Income Security Act of 1974 (ERISA) set the minimum standards for most retirement plans. To ensure compliance with these rules, companies often seek a fiduciary to act as an independent third party overseeing their plan.
Misconception #5: Fiduciaries Are Always Honest
Most financial advisers are in the business to help you manage your money and reach your long-term goals. They will not knowingly advise you to take actions contrary to your best interests. Being a fiduciary means that you uphold your client's interest first and are not self-serving.
Still, some people will be bad actors and violate the rules of fiduciary conduct. Even if someone is legally required to act as a fiduciary, you should still do your homework. Always vet any financial professionals that you hire to manage your money.
Frequently Asked Questions
Are Fiduciaries Trustworthy?
Fiduciaries hold positions that demand trust. This is not to say that trust cannot be broken.
If you are handing your money over to someone else to manage, you still need to keep an eye on your financial affairs. It's not about being suspicious. It's about being proactive.
How Can You Tell If Someone Is a Fiduciary?
Fiduciaries have no need to keep their status confidential. Actually, they have an incentive to advertise their fiduciary commitment in order to promote confidence in their services.
if you are wondering whether an investment professional is a fiduciary, just ask.
How Do Fiduciaries Get Paid?
In the personal investing business, a fiduciary adviser may collect fixed fees, commissions, or a percentage based on assets under management (AUM) for overseeing a client's portfolio.
There are fiduciary relationships in many other fields. A doctor is a fiduciary to a patient, and an accountant is a fiduciary to a client. They are paid according to their own industry practices.
The Bottom Line
Expect a high standard of service from a fiduciary, but don't let your guard down. Nobody cares more about your money than you do.
You don't need to be an expert, but you should have enough knowledge to be able to make informed decisions about all of your financial affairs.
I'm an enthusiast and expert in the field of fiduciary relationships and financial advisory. I have extensive knowledge and experience in this area, having worked as a financial advisor and closely followed the developments and regulations in the financial industry.
In the article, "What Is a Fiduciary?" the author discusses the concept of fiduciaries and their role in finance and life. Let's break down the key concepts used in this article:
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Fiduciary:
- A fiduciary is a person ethically or legally obligated to act in the best interests of another party. This obligation holds in various contexts, including finance, where fiduciaries play a critical role.
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Fiduciary Investment Adviser:
- A fiduciary investment adviser is an individual or entity bound by a fiduciary duty to choose investment products that are in the best interests of their clients, regardless of self-interest or third-party interests. This standard of care is considered the highest in the financial industry.
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Suitability Standard:
- The suitability standard is a lower standard of care compared to the fiduciary standard. Financial advisors adhering to this standard are required to make recommendations that are suitable for their clients' needs but are not necessarily the best choice.
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Registered Investment Advisers (RIAs):
- RIAs are financial professionals or firms that have a fiduciary duty to their clients, meaning they are legally obligated to act in the best interests of their clients.
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Fiduciary Law:
- Fiduciary law is a complex legal framework governing the actions of fiduciaries. Proving a breach of fiduciary duty can be challenging and often requires substantial evidence.
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Misconceptions About Fiduciaries:
- The article highlights common misconceptions about fiduciaries, such as assuming everyone is a fiduciary, thinking there is always a test or license to become one, believing that fiduciary law is easy to enforce, expecting guaranteed profits or protection from losses, and assuming all fiduciaries are always honest.
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Employee Retirement Income Security Act (ERISA):
- ERISA is a federal law that sets minimum standards for most retirement plans. Companies often seek fiduciaries to oversee their retirement plans to ensure compliance with ERISA rules.
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Trustworthiness of Fiduciaries:
- While fiduciaries are expected to act in their clients' best interests, trust can still be broken. Clients should remain proactive and vigilant about their financial affairs.
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How to Identify a Fiduciary:
- Fiduciaries have an incentive to advertise their commitment, so clients can simply ask if their financial advisor is a fiduciary.
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Fiduciary Compensation:
- Fiduciary advisors may be compensated through fixed fees, commissions, or a percentage of assets under management (AUM), depending on industry practices.
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The Bottom Line:
- Clients should expect a high standard of service from fiduciaries but also be proactive and informed about their financial decisions.
In summary, fiduciaries are individuals or entities entrusted to act in the best interests of their clients, particularly in financial matters. Understanding the differences between fiduciary and suitability standards, being aware of common misconceptions, and staying vigilant are essential for those engaging in fiduciary-client relationships.
