What is a Fiduciary?

What is a Fiduciary? You’ve likely heard of it before, people telling you that you should be working with a fiduciary. We’ve talked about it before, but you may be unclear about what we are saying. Let’s be clear on what a Fiduciary is and why it matters. Working with a Fiduciary is critically important to your success.

What is a Fiduciary?

A Fiduciary is a professional who must act in your best interest. There are fiduciaries in other industries, but in finance, it means a Financial Advisor who gives advice and recommendations in the best interest of the client, not in their own best interest. This standard of behavior and recommendations is called the Fiduciary Standard.

The other option in finance is the Suitability Standard. Those operating under this standard may recommend anything to clients as long as it is suitable. Hear that loud and clear. If your financial professional is not a Fiduciary, then they are working under the suitability model and they can put their financial interests ahead of yours.

Why Working with a Fiduciary Matters

Here is why this matters. Let’s say you are retiring and you are working with a financial professional. They have two options they are looking at.

How does this play out?

I explained this to a potential client once and they exclaimed, “Why would anyone work with someone who isn’t a fiduciary?!”

Good question.

Financial Advisors vs. Financial Representatives

I share the belief of a growing movement that states that all “advice” should automatically be in someone’s best interest. Therefore, no one should be able to call themselves an “advisor” if they are not also a Fiduciary. A wholly separate category, then are “Financial Representatives.” These professionals represent the companies they work for and sell financial products.

Unfortunately, insurance companies, broker-dealers, and other non-fiduciaries enjoy the confusion around the word “advisor,” and thus far have successfully lobbied to quash this from being fully implemented. Thus, many still call themselves “advisors” who are truly just financial sales professionals. I try and avoid using the term “Financial Advisor” as it is confusing what we mean. We’ll discuss Fiduciary Advisors or Fiduciaries as those abiding by the fiduciary standard, and Financial Representatives or Reps as those only following the suitability model.

Suitability Pays Better than Fiduciary

There are many more financial professionals in the Suitability column than in the Fiduciary column. True Fiduciaries are harder to find, and if you don’t know the difference you will almost certainly end up working with a suitability-based financial rep. Why are there so many more Financial Reps than Fiduciary Advisors? Suitable financial products pay professionals more than fiduciary financial strategies.

Strategy vs. Product

Let’s go back to our Options A & B and consider that the client has $300,000 to put into one strategy or the other.

The fees and penalties make the annuity a worse option. But it pays the professional much better. Let’s look at that pay again.

Ongoing Service vs. One-Time Payday

One more time, for clarity.

Fiduciary Advice vs. Suitable Sale

Can you see why there are more representatives than fiduciaries? Can you see why more people would be likely to recommend suitable products than fiduciary strategies? The difference in payday is compelling.

The Bottom Line

Working with a Fiduciary matters. If you are not, you may:

No one in their right mind would work with a Financial Representative rather than a Fiduciary Advisor. But how can we tell the difference?

How do I Know if I am Working with a True Fiduciary?

No one in their right mind would work with a Financial Representative rather than a Fiduciary Advisor. But how can we tell the difference? Part of the struggle is that many people will call themselves fiduciaries when they aren’t. Let’s break down how to identify true fiduciaries.

Technical Fiduciary vs. Practical Fiduciary

Let’s distinguish between what legally makes you a Fiduciary and what practically motivates professionals to act in the client’s best interest.

Technical Fiduciary: Legally Required

According to the current law, the sale of financial products for a commission is done under the suitability model. Product sales must be suitable for a client, but they do not have to be best for a client.

Those who get paid a fee for service as opposed to a commission must render that service or advice under the Fiduciary Standard. If you are paying a firm an Advisory Fee to manage your investment accounts, those accounts must be managed in your best interest. If you are paying a Financial Planning Fee, all of those recommendations must be in your best interest.

Here is a shortcut to knowing if your professional is a Fiduciary or a Sales Professional:

If you do not see the fee, they aren’t Fiduciary.

If they are putting together a “Financial Plan”, but you haven’t paid them a fee to do so, none of those recommendations are required to be in your best interest. If they “work for free” or “get paid by the companies they work for” and not by you, they are representatives of the company and not fiduciaries to you.

Practical Fiduciary: Practice What They Preach

A practical fiduciary actually gives advice in a client’s best interest. Some sales representatives are practical fiduciaries. They may not be legally required to recommend strategies or products in your best interest, but they do in practice because they are competent and trustworthy professionals. However, it can be hard to tell if someone who is not legally a fiduciary is practically acting like one. And if they are practical fiduciaries, what’s stopping them from becoming technical fiduciaries?

Many (but not all) technical fiduciaries are also practical fiduciaries. Why not all? How can you be legally a fiduciary but not practically one? Loopholes.

Fiduciary Loopholes

There are four loopholes that allow professionals to legally call themselves fiduciary, though they are not one in practice.

Fiduciary Loophole 1: Partial Fiduciary

A professional can be a hybrid professional, working through a broker-dealer or insurance company for commissions, and an Investment Advisor for investments. A common version of this is professionals who manage investment accounts for a fee. This means they must manage those accounts in the client’s best interest and are legally a fiduciary on those accounts.

But they are only a fiduciary on those accounts. They are free to make recommendations (a.k.a. sell products) on other money that are only suitable for clients. But they can truthfully answer the question:

“Are you a fiduciary?”

With:

“Yes, I am a fiduciary.” I am a fiduciary on your fee-based accounts.

Fiduciary Loophole 2: Switching Hats

Fee-for-service financial planning is supposed to help with this. Someone can be a fiduciary only on your accounts, but then be only suitable with insurance recommendations. But if you pay someone a financial planning fee to give you advice across all areas of finance, now the professional has been paid a fee, so all their recommendations must be in your best interest, right? Yes. Unless they switch hats.

For example, a professional may determine that it would be in your best interest to own life insurance to cover your minor children. In their fee-for-service fiduciary financial plan, they might have this recommendation:

• Obtain life insurance to protect your family.

Perfect. It’s all on the up and up. You do, in fact, need life insurance. It’s in your best interest. But they didn’t specify how. What kind of insurance do you need?

They can then “switch hats” from fiduciary to representative, and as a representative, they can recommend that you buy expensive permanent life insurance instead of term insurance. Said another way, they can recommend a product that’s ten times as expensive and pays them ten times more. The general recommendation was in your best interest—the specific product was in the professional’s.

Do companies really do this?

Yes.

I used to work for a firm whose parent company was a Fortune 100 insurance company. I remember vividly when the financial planning contract was rewritten. It specifically disclosed in the contract that the professional would be acting as a fiduciary in the financial plan, but would be acting as a representative of the parent company when recommending specific insurance products.

It’s baked right into the contract. “We are fiduciaries. Except when we aren’t.”

Fiduciary Loophole 3: Drinking the Kool-Aid

Many firms, especially large broker-dealers and insurance companies, have terrific sales cultures. Terrific for them, anyway, not necessarily for you.

Most of their training, focus, and recognition is on the amount of commission earned and products sold. Little to no emphasis is placed on fiduciary strategies. If you are surrounded by a culture that focuses so heavily on suitability sales and not at all on fiduciary advice, it is easy to start drinking the Kool-Aid.

I know lots of really good people who work for insurance-based firms and broker-dealers. Many go to my church. They’re in my community. They are good people. And I also know that they are recommending really bad products that pay them a bunch and are not good for clients.

Why do good people recommend bad products?

The worst part is that these people believe they are acting in the client’s best interest. They think they are doing the best thing for clients. They have been so inundated with sales training and company culture that they believe their advice is fiduciary advice.

And the incentive for them to believe it there, right? Let’s refer back to our example.

The sale will pay them 28 times more right now than the advice. Don’t you think that would skew their view of the product a little bit? Is it possible that the promise of a huge payday could coax even good people into rationalizing that the product is best, even though they know deep down that it’s not?

As W. Edwards Demming once said, “A bad system will beat a good person every time.”

Fiduciary Loophole 4: Incompetence

Some professionals simply don’t know any better. All or most of their training has been in sales and in product knowledge. They think being a “financial advisor” is about finding the best products for people.

“Product XYZ is the best in its class. Therefore it’s in the client’s best interest to recommend it.”

They are ignorant of the best strategies. So how can they recommend them?

A True Fiduciary

A True Fiduciary is one who technically and practically acts in the client’s best interest in everything. You don’t want to work with someone who claims to be a Fiduciary but squeezes through the loopholes. You don’t want to work with someone who has practically been a fiduciary before but is under no obligation to do some in the future.

Work with someone who legally must act in your best interest in everything, and who practically does so. Work with a True Fiduciary.

How do I Know if I am Working with a True Fiduciary?

It can be hard to tell if a professional is a true fiduciary. There are a few red flags that will tell you when you are not working with one. The first, again, is easy.

If you have never paid them a fee, whether a flat fee or a percentage fee, they are not a fiduciary. None of their past or future recommendations need to be in your best interest. Here’s another:

Most companies have ways of getting out of being a fiduciary when it comes to insurance and annuity recommendations. So if they sell them, they probably aren’t true fiduciaries. Minimally, the burden of proof would be on them to demonstrate why it’s a best-interest recommendation. Guilty until proven innocent.

What’s the Easiest Way to Determine a True Fiduciary?

Rather than focusing on all the ways someone may not be a fiduciary, what’s the easiest way to determine if they are?

To ensure they are a True Fiduciary, work with a Fee-Only Fiduciary Certified Financial Planner.

What is a Fee-Only Fiduciary Certified Financial Planner^TM?

Let’s break it down.

Fee-Only: No commissions. Ever.

“Fee-based” advisors offer services for a fee, but they also offer commission-based products. Therefore some of their work is fiduciary, and some of it is probably not.

“Fee-only” advisors are only paid by you, the client. They never sell commission-based financial products and disclose all fees.

No “Partial Fiduciary.”

No “Switching Hats.”

Full Fiduciary, all the time, about everything.

Fiduciary: Best Interest. Always.

Since you know what a True Fiduciary is now, we won’t belabor the point.

Certified Financial Planner: Verified Expertise. Comprehensively.

The Certified Financial Planner^TM designation is the gold standard for comprehensive financial planning competence and expertise. Without the right training, an advisor could simply be ignorant of the best solutions. If they don’t know what would be in your best interest, how can they recommend it?

The Financial Advice Trinity

You could call these three the holy trinity of financial advice. Or the trifecta. While it’s possible to have a True Fiduciary who isn’t technically fee-only or a CFP, the easiest way to confirm it is to find someone with the trifecta.

What’s the Fastest Way to Find a True Fiduciary?

The fastest way to find a Fee-Only Fiduciary Certified Financial Planner^TM is to go to FeeOnlyNetwork.com. Everyone listed on that site is all three. While we are the minority, there are plenty of us out there.

You are also welcome to check out my firm, La Crosse Financial Planning. We are a Fee-Only Fiduciary Firm, and all advisors best be a CFP® or earn it within two years (the fastest you can obtain it).

Demand to work with a True Fiduciary. Supply follows demand. The more households there are that only want to work with a Fee-Only Fiduciary CFP, the more firms and advisors will switch over to the client-first model. I’m passionate about this topic because I believe that we can turn the tables. We can get good people to switch to good systems. And we can get more and more people the best-interest advice they deserve.

This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are the opinions of the people expressing them. Any performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be directly invested in.