Is My Advisor a Fiduciary?

    And What That Means for Your Investments

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    Listen, there is an “F” word you really need to know.

    In fact, you might have heard this “F” word in the news before, and thought, That sounds like something only old people care about. I mean, seniors. (Sorry, Mema!) That’s right, the word of the day is “fiduciary.” Not knowing what the fiduciary standard is could be costing you big bucks and reducing your future wealth.

    Curious? Knowledge is power, so read this quick article and protect your wallet.

    Let’s talk about what it means to be a fiduciary, why you should care (money in your pocket), and how to figure out if your current (or future) financial advisor is a fiduciary.

    Is my advisor a fiduciary? The CFP Board (certified financial planner) states that the fiduciary standard requires the “financial advisor act solely in the client’s best interest when offering personalized financial advice.” Translated into English, financial advisors must place the best interest of their clients before their own. Seems straightforward: If it’s better to put the client in XYZ mutual fund, instead of ABC mutual fund, the financial advisor must do that.

    Except, that often doesn’t happen.

    Did you know that the vast majority of financial advisors do not operate under a fiduciary standard? These advisors only have to meet the much lower bar of “suitability,” which essentially states: If you could argue that it is not unreasonable to put the client in mutual fund ABC, then that’s fine. Even if it costs the client (that’s you) more money.

    Clear as mud? Perhaps an example will help. Let’s say you want to invest $50,000 in the S&P 500 index. In our vastly simplified world, your advisor has two options:

    A) Suggest you invest in an extremely inexpensive S&P 500 index ETF (a fund traded on stock exchanges) that costs 0.1 percent annually. This investment would cost you approximately $50 a year.

    Or

    B) Suggest you invest in an A-share S&P 500 index mutual fund with an expense ratio of 0.5 percent annually, that happens to pay your advisor a 4 percent sales load, plus an annual 12b-1 fee of 0.25 percent. This means your first-year fee would be $2,375, and the ongoing fee after that would be $375 year.

    After ten years, your ETF (option A) would cost you about $500, but the mutual fund (option B) would cost you about $5,750 in fees. You don’t have to be awesome at math to see why fees matter.

    Even though option B has a relatively low expense ratio (0.5%), the other fees significantly increase the cost of your investment. Under the suitability standard, your advisor could invest you in option B, regardless of whether or not that was the best choice for you. Compare this to an advisor operating under the fiduciary standard who is required to act solely in your best interest. A fiduciary would likely choose the lower cost alternative when considering two comparable investments.

    So, how can you protect yourself and your money? Start by asking how your advisor is paid. Is he or she paid by mutual fund companies to place your money in their funds (i.e. on commission)? Or do you pay them directly? If you think you don’t pay your advisor, then your advisor is probably being paid by mutual fund or insurance companies. This presents a potential conflict of interest.

    Another distinction: Registered investment advisors (RIAs) are required to act as fiduciaries. Broker dealer representatives (registered reps) are not required to act as fiduciaries.

    Start by asking your advisor flat-out:  Are you a fiduciary? If so, request an acknowledgment of fiduciary duty in writing.

    Just because an investment advisor is fee-only does not mean she is a fiduciary. An advisor who charges a percentage of assets under management (the money you invest with her) is not necessarily a fiduciary.

    For example, let’s say you receive a $30,000 bonus (we can dream, right?). You might wonder if you should invest that money in your portfolio (which your advisor would be paid on) or pay down your mortgage (which your advisor would not benefit from). A fiduciary would be required to work out the pros and cons with you to determine what is truly best for you. A financial representative operating under the suitability standard could simply pitch you to invest the money with him, without determining what is actually in your best interest.

    What about fee-only versus fee-based? Consumers have become more aware of the important role of the fiduciary advisor, which has led some financial salespeople to start referring to themselves as fee-based. This is not the same thing as fee-only, and should be considered a red flag. Whenever you see fee-based, recognize that what they really mean is commission and fees. The term fee-based was deemed to be so misleading that CFP Board practitioners may not use the term in describing their compensation.  It’s not that all commission-based advisors are out to take advantage of you, you just need to know how your advisor is paid, and be prepared to ask hard questions.

    Could I be biased? You might say I am, because I choose to work as a fee-only fiduciary advisor. I choose to provide advice to people in this way because I firmly believe it is in a consumer’s best interest. Sunshine is a powerful disinfectant when it comes to politics, and the same can be said for finance.

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    Lauren Zangardi Haynes
    Lauren Zangardi Haynes CFP(R), CIMA is a fee-only financial planner with Evolution Advisers in Midlothian. She has three kids (ages seven and under) and an elderly miniature schnauzer. Lauren is also the founder of a personal finance blog for families with kids at home called Words on Wealth.