Choosing a Financial Advisor, Part 3

“Fiduciary – A Financial Advisor held to a Fiduciary Standard occupies a position of special trust and confidence when working with a client.  As a fiduciary, the Financial Advisor is required to act with undivided loyalty to the client.  This includes disclosure of how the Financial Advisor is to be compensated and any corresponding conflicts of interest.” – Focus on Fiduciary.

In a previous post, I said that, when looking for a financial advisor, you want someone who puts your interests first, i.e. a fiduciary.  This merits further discussion.  By way of example, lawyers, trustees or doctors are considered fiduciaries. On the other hand, stock brokers, insurance agents and registered representatives are not.

According to the National Association of Personal Financial Advisors (NAPFA) web site, Focus on Fiduciary:

Federal and state law requires that Registered Investment Advisors are held to a Fiduciary Standard.  This law requires that an advisor act solely in the best interest of the client, even if that interest is in conflict with the advisor’s financial interest. Investment Advisors must disclose any conflict, or potential conflict, to the client prior to and throughout a business engagement.  Investment Advisors must adopt a Code of Ethics and fully disclose how they are compensated.

Because broker-dealers are not necessarily acting in your best interest, the SEC requires them to add the following disclosure to your client agreement.  Read this disclosure, and decide if this is the type of relationship you want to dictate your financial security:

“Your account is a brokerage account and not an advisory account.  Our interests may not always be the same as yours.  Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest.  We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.”

If you see this disclaimer in your contract, you have been warned that you are not working with a fiduciary.  My question to you is, “Why would you even consider working with someone who has issued you this warning?”

After all, you engage a financial advisor to look after your interests. In my opinion, having a trusted relationship is not possible after you have read the warning quoted above.  Since commissioned representatives receive incentives for selling one investment over another, how do you ever know why someone recommends one investment product to you over another? How do you know what it is actually costing you?

I wholeheartedly agree with NAPFA’s conclusion:

NAPFA has always maintained that an advisor who is compensated solely through commissions faces immense conflicts of interest.  This type of advisor is not paid unless a client buys (or sells) a financial product.  A commission-based advisor earns money on each transaction—and thus has a great incentive to encourage transactions that might not be in the interest of the client.  Indeed, many commission-based advisors are well-trained and well-intentioned. But the inherent potential conflict is great.

I believe that a strict fee-only approach is the best way of working with clients.  I want my clients to consider me as a trusted advisor and true partner, not a salesperson.

To be continued.

photo credit: Rui Almeida (Portugal)