Many Are Not Obligated To Serve Your Best Interests
Assumptions can kill your financial plans. One of the worst assumptions is thinking your investment or financial consultant is legally obligated and motivated to serve your best interests. That may not be true.
Many high net worth individuals and business owners believe their professional and credentialed financial expert is legally bound to and compensated for providing financial and investment advice that’s in the client’s best interest. That describes what a fiduciary does. A fiduciary, by law, must give advice that’s in the client’s best interests. Financial advisors aren’t acting in a fiduciary capacity if they accept commissions. Instead, advisors acting in a fiduciary capacity charge fees for their investment advice. But many professional financial experts (like broker-dealers) are not so bound, not so motivated, not so compensated. Instead, they are rewarded by commissions, rewarded by selling, and not legally bound to serve the best interests of you, the client.
Most Financial Consultants Have High Integrity
Let me stop here. I know I’m sounding critical. Please know that I believe the financial services industry has many caring financial consultants of high integrity. Most of them want to do what’s in their client’s best interest. But a lot of them operate within a system that pays them for sales, not for putting client interests first.
One key is for you to know if your consultant is a fiduciary. If not, your consultant is only obligated to offer you investment and financial products that are “suitable.” Non-fiduciary financial consultants do not have to always recommend what they think is in your very best interest.
What’s A Registered Investment Advisor?
It’s important to clearly understand this difference between a fiduciary who is a Registered Investment Advisor (RIA) and other financial consultants who are not fiduciaries. So I’m going to repeat and expand. A fiduciary is a legal standard adopted by only some independent financial professionals. These professionals, when registered as investment advisors, are legally required to remove or disclose any conflicts of interest and always put their client’s needs first. A conflict of interest could be recommending that you buy the XYZ Mutual Fund without disclosing that the RIA will receive a commission, and that the receipt of a commission may be considered an incentive for him or her to make the recommendation based on his or her own financial gain.
Under the Investment Advisers Act of 1940, Registered Investment Advisors are held to a fiduciary standard of care. By law, they must ensure that each investment recommendation they make is based on your best interest. Additionally, RIAs are required to have a written code of ethics that governs their actions. They also must fully disclose how they are paid.
Brokers are typically compensated by commission. They sell you a product, such as a mutual fund, which includes a sales charge (or load) and they receive a portion of the sales charge as compensation. The largest brokerage firms have proprietary funds (funds the firm owns) and brokers are often encouraged to recommend these funds over any other funds. Traditional brokers must adhere to some important obligations. The most important obligation is providing the firm with revenues. They get paid to sell you products. They generate their income through commissions, the fees you pay each time the broker makes an investment transaction. So, it’s in the best interest of both the broker and the firm he works for to generate increased revenue through maximizing trading commissions.
All This Can Get Confusing
I’m trying to explain this clearly but in the real world things get confusing for at least four reasons. First, did you know the Wall Street Journal found there are literally more than 200 different financial designations that financial consultants use? Many signify a true depth of financial knowledge but many do not. A second cause for confusion is that firms and their representatives can be dually licensed, meaning they are both commission-based and fee-based.
Third, most brokerage firms aren’t large enough to offer proprietary products but they still might have financial incentives to sell products rather serve the client’s best interests. And fourth, many RIAs also provide some products that are commission-based, although they often reduce their fees by the amount of commissions they earn. For example, my business, Summit Investor Coach, LLC is an RIA so I receive only fees for my investment advice. However, I do sell some insurance products that the insurer compensates me for with commissions. When I earn a commission, I do not charge a fee for my investment advice if I am acting in a fiduciary capacity.
How can you cut through this confusion? Make sure you’re working with an RIA. You can also go well beyond taking my word for all of this. Read the Securities and Exchange Commission’s Study on Investment Advisers and Broker-Dealers. The study recommends a “uniform fiduciary standard of conduct for broker-dealers and investment advisers.”
In his November 2014 book, Money: Master the Game, entrepreneur Tony Robbins recommends aligning yourself with a financial fiduciary, a Registered Investment Advisor. Robbins calls working with an RIA the one most important step you can take toward striving for financial freedom.
RIAs are independent. These advisors are not affiliated with a brokerage firm. Their independence is key to their mission of offering investment advice based on what’s best for you, the client. RIAs can be flexible and customize services to meet the client’s unique needs. RIAs can offer advice for more complex needs such as retirement planning, tax situations, estate planning, and assets at multiple places.
Managing $38 Trillion for 14 Million Clients
One reason this issue is so important concerns size. According to the SEC (page iii of the report referenced above) “investment advisers” manage $38 trillion for 14 million clients. That’s a lot of money. That’s a huge chunk of the future financial fortunes of millions of Americans.
Find out if your investment or financial consultant is a fiduciary (RIA.) You can do so at the Investment Adviser Public Disclosure website. I urge you to think about whether you might be better off with an advisor legally bound to always provide you with advice that’s in your best interest.
by Gene Thomas Offredi, CFP®, RFC™ Contact Gene at the Summit Investor Coach website or call 203.453.1017. Download Gene’s free guide Plan, Retire, Relax.
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