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Should Your Financial Advisor Have a Fiduciary Duty to You?

by Ryan Guina

It’s a sad fact, but brokers don’t always act in your best interest. And there is nothing that requires them to. It may be hard to believe but brokers, investment specialists, insurance agents, some financial advisors, and other professionals that you trust with your money aren’t always required to act in your best interests.

Suitable vs. fiduciary standard. Brokers are required to recommend “acceptable” or “suitable” investments, but “suitable” doesn’t mean the best performing stock or investment, just that it is an appropriate investment. As a result, some brokers recommend investments with higher commissions. Registered investment advisors, however, are required to follow a fiduciary standard, which means they must put your interests before their interests. An example would be choosing the fund with the lower expense ratio. (Read more about this as it applies to financial reform).

Should investment professionals be required by law to act in your best interests?

Financial advisor fiduciary duty

Is your financial advisor acting in your best interests?

There are many people calling for change in the financial and insurance industries to require professionals to act in the best interests of their clients at all times. Unfortunately, there is no current requirement.

I have had two bad experiences with financial advisors – once with an independent broker and once with a broker who worked for a well-known investment firm. These two bad experiences changed the way I act toward investing by forcing me to earn more and become more hands on with my approach to investing.

My $1,000 investing mistake. My first bad experience involved meeting with an independent broker who was recommended by a coworker. At the time I didn’t know much about investing or even enough to do a background check on the broker. At the broker’s recommendation I bought into a front loaded mutual fund that essentially tracked the S&P 500, and not only charged a large front load fee ($1,000), but had an ongoing 1.5% expense ratio.

After a couple years I learned more about investing and realized the fund I had invested in was not the best investment for me. I moved the investment to Vanguard where I paid much lower expenses, but unfortunately, the load fees were gone forever. This was an expensive mistake, but in a way I’m glad it happened. I learned more about investing and it prevented me from making more expensive mistakes later on. You can read more about this mistake in this article about why you should research investments before buying.

The broker who interests trumped mine. The next situation came several years after the first, and I was wiser and more fiscally responsible. I had done some reading on investing and was ready to contribute beyond the $3,000 I was contributing to my Roth IRA each year (back when IRA contributions were capped at $3,000).

I set up an appointment with a financial advisor at a well-known firm. I was seeking advice about developing financial goals and how/where I should invest. After listening to my situation he handed me a one page fund sheet and told me that was the fund I needed to purchase. Before I had finished reviewing the sheet or asked any questions about it he essentially shuffled me to his secretary. But along the way he was nice enough to ask me to leave a canceled check so they could immediately begin an automatic investment plan. He also gave me a stack of business cards to hand out on base (they made it as far as the trash can outside his office door).

Needless to say, I didn’t hand over the blank check before leaving. I went home and researched the fund and discovered it had a very high expense ratio and probably a high commission as well. I don’t think all funds with high expense ratios are bad, but this fund was another mirror of a popular large cap index fund. In no way was it better than what I was already doing. This broker put his needs before mine by trying to sell me a high priced fund without taking the time to explain to me why this was the best option for my needs (he brushed off most of my questions during the short appointment).

The common denominator: In neither case were my interests as an investor placed first. Both of these examples served the financial advisor more than they served me. In the first example, I made an expensive mistake and the broker received a nice commission for his sale. But it also prevented me from making a similar mistake the next time I visited a financial advisor.

Reader question: Should all financial brokers, advisors, insurance agents and others be required by law to follow a fiduciary standard of care – that is to say, put the interests of their clients ahead of their own interests?


Published or updated March 28, 2013.
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{ 16 comments… read them below or add one }

1 Hank

Ryan,

I had a very similar experience like your first example. Luckily I managed to get away before I invested too much in a front in load fund…only a couple of hundred dollars instead of thousands. I have had much better luck just doing all my investing myself, and I enjoy it. I haven’t been back to a financial advisor since getting that hard sales pitch. The same guy also sold me whole life insurance too! Have you found a financial planner or advisor that you like? Or, are you going it alone?

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2 Ryan

Mine was an up front $1,000 payment before anything else went to the investments. Then there was a 1.5% management fee on top of that. Boy did I make a mess for myself by not understanding the investment better!

I’m currently handling my investments, but I’m ready to visit a fee only planner. Hopefully I can get some valuable advice that will help me better plan for the future.

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3 KP

Ryan,

In a perfect world, perhaps we could expect to have such a high standard where financial advisors and others put their clients above their own personal interest. However, this expectation is unrealistic.

In order to protect our own best interest we must be willing to build the knowledge (as you did) and make the best financial decisions for ourselves. Starting by asking questions and taking the time to understand any financial products (fees, costs, etc) we are considering.

As Warren Buffett says “The ability to say “no” is a tremendous advantage for an investor.”

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4 Ryan

KP, I agree – ultimate responsibility lies in the hands of the investor, “caveat emptor.” And in a perfect world, people would have a strong financial background and know the questions to ask and would understand what to look for.

But the truth is that the majority of the general public has little specialized investment knowledge and many people rely on advisors for the best investments, products, and services for their situation. Unfortunately, there is a segment of the industry that preys on people who are looking for financial planning help and don’t know better.

My experience inspired me to learn more about money management and investing, so even though I made a large financial mistake, I came out ahead in the long run. But there are many other people out there who simply don’t know better and have no reason to think their advisor isn’t working in their best interests.

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5 Kirk Kinder

I can’t be objective here as I am a fee-only planner who acts as a fiduciary. However, I never intended on entering this profession. I only did so after years of investing with a broker. My eyes didn’t open up for four or five years, but when they did, it motivated me to enter this highly unethical industry.

I do not know why anyone would entrust their financial lives to someone who doesn’t have a legal obligation to put their interests first. Would you take advice from a doctor who was paid by the insurance companies for selling pharma products? Of course not. How is this any different. Commission planners and advisors are used car salesmen with better suits.

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6 Ryan

Great point, Kirk. I think the key here is to understand all aspects of your investments, including how your advisor or broker is paid, all related investment costs and fees, and whether or not the broker is required to act as a fiduciary.

I take full responsibility for my early mistakes – I’m only happy I learned from it early on and hopefully I can help others be aware of similar situations.

But there are also many people who will never take the time to learn about their investments or insurance products and many of them will blindly trust the person they believe is acting in their best interests.

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7 Jim

Short answer. No more laws.

There are a lot of scum out there that will rip you off. But these laws won’t protect you, and in fact will probably make things worse.

First problem is how you define and measure “best interests”. Taken to an extreme, it could be rationalized that nobody should allowed to be paid for their services because it is not in the client’s best interest to pay for anything. This means we must have public-only “investments” like social security.

Second problem is compliance costs. There are too many laws and regulations already which are squeezing out smaller, and sometimes more honest firms. One high profile example is Peter Schiff. He talks about how he started his own firm in a one-bedroom apartment cold-calling people warning about the coming dot-com bubble. He worked at Goldman Sachs before that and quit because he felt that they were screwing their little customers in favor of their big corporate clients. He says with all the laws passed in the last 10 years (like the Patriot Act which is really just rationalized financial spying on American citizens), he could have never started his own business because the legal costs for compliance are now too high. And they don’t do a thing to protect the end consumer (Enron and Bernie Madoff still happened), but only entrench the companies big enough to absorb the compliance costs.

The best protection is more competition (by less regulation) and due diligence on the investor’s part.

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8 Ryan

good insight, Jim. I agree the best protection is due diligence, but many people don’t know where to start and are simply looking to start somehow/somewhere. That was my case.

I lost some money, but turned it into a valuable learning experience. It would be impossible to know for sure, but my guess is the majority of people never learn about the better options available to them because they have effectively been fed a string of lies.

In the end it’s buyer beware and my goal is to try and help people be aware of the situations they may face.

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9 basicmoneytips

Unfortunately this is more common than we would like. Financial advisors are also a form of salesmen, they are selling products that their company is responsible for, and they do not get paid if they do not sell. I would stick to people you know or friend who refer someone too you.

Just walking into your local Edward Jones office is not the way to go in my opinion.

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10 Ryan

BMT, my experiences were similar to meeting a salesman. I will likely use a financial advisor in the future (I currently do everything myself), but it will be a fee only planner who I will research, interview, and speak with several times before trusting him with my future. This was an important lesson for me to learn, and even tough it cost me money, I think I came out ahead because it inspired me to learn more about money management.

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11 Derek Epperson

My simple two cents – you can only legislate ETHICS to a point. And I think that’s really where this falls under.

Sure Financial Advisors have to make a living too, but ETHICS should be top of their list – which in a utopian world would mean everyone should benefit.

Unfortunately, the lack thereof gives many financial industries a bad name – and sometimes rightly so.

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12 Darren

Ryan, sucks to hear you had not one, but two bad experiences with advisors.

I’m sure not all advisors are this way, but stories like this held me back from pursuing a career as an advisor. I’m not sure I’d make it if I truly had my clients’ interests first. I think it can be done, but it’s an uphill battle.

Anyhow, it looks like you’ve learned your lesson, and can use your blog as an outlet to teach and warn others.

I thought financial professionals DID have a fidiciary duty towards you, but I guess I need to read more into it.

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13 Ryan

Darren, some financial planners are required to follow a fiduciary standard, while others don’t have such stringent requirements. There are plenty of honest financial advisors who put the investors needs first. The key is interviewing a potential financial advisor about how they are compensated, ask them if they are required to follow a fiduciary standard, and ask other relevant questions.

I briefly thought about becoming a broker at one point until the I read the job description of the company I was considering – it was basically a sales position that required cold calls, high sales volumes, rewarded brokers with trips and vacations based on sales volume and other tactics I didn’t agree with. After more thorough research I discovered they have very high commissions and expensive funds. I wouldn’t feel right pitching those offerings to friends and family, so I wouldn’t do it to anyone else.

That said, there are many ways to be a financial planner or broker and remain ethical and profitable. It’s an interesting field. :)

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14 Darren

I’ve also interviewed with some companies whose practices I felt were questionable. They’d want me to sell to friends and family, but if I did, I doubt they’d be my friends amymore!

Are you in the field now?

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15 Ryan

I had the same feelings about some of the companies I looked into. I wouldn’t feel right pitching high commission products to family and friends.

I’m not in the field. I run this site as a hobby/business, but I don’t do any direct financial advice such as buying/selling equities, etc. The extent of my advice is practical financial concepts and applications and I don’t charge for it. ;)

16 Kim

Ryan,

No amount of legislation will protect an investor from unscrupulous, desperate or clueless advisors. It doesn’t matter whether they are fee based or commission based. If someone is not ethical, no law is going to make them. The onus is on the customer to research and work with someone that matches their expectations.

I went into the business years ago because I too experienced bad investment advice including those from people who were “friends”. I’ve seen bad fee advisors and bad commissioned advisors. How they charge does not matter. It’s how they do business.

Regulations is driving a lot of decent advisors out of the industry because of the sheer amount of paperwork. The people who care and who do the due diligence are being buried by compliance while the ones who don’t care, don’t do anything. When I take on a new client, it is about 80-100 pages of paperwork to fill out. I constantly have to look for new technology to streamline entering someone’s SS# 27X to start.

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