How to tell if your Financial Advisor is acting in your best interest?

As of June 9th, 2017, the Department of Labor’s so-called Fiduciary Rule is here.

What is the Fiduciary Rule and why is it so important?  First, let’s properly define: ‘fiduciary’.  A fiduciary is someone who is required to act in the best interest of someone else.  The term is often used pertaining to the trustee of a trust.  For example, in the case of money being set aside in a trust for a minor, the trust will usually have a trustee that is designated to make decisions about how the money will be managed.  This money is not for the benefit of the trustee but rather the beneficiary.  The trustee is required by law to make decisions that are in the best interest of the beneficiary.  This duty is summarized most simply as the trustee’s ‘fiduciary duty’.

Who can act as a fiduciary?

Similarly, in a case where someone else has decision making power concerning someone else’s assets, a fiduciary standard can apply.  In the world of financial advice, there are financial advisors that are fiduciaries all the time, financial advisors that are NOT fiduciaries and financial advisors that are fiduciaries some of the time.  In layman’s terms, these advisors are either required to act in their client’s best interest all the time, some of the time or not at all.  Are you surprised by that?  Many people are.  

There are two standards you need to understand.  One is the fiduciary standard which we have just discussed.  The other is the suitability standard.  Many brokers or financial advisors make investment recommendations that are merely suitable some or all the time as opposed to acting in their client’s best interest ALL the time.  It sounds picky, ‘best interest’ vs. ‘suitable’.  But when you think about it, the standards are quite different.  Generally, fee-only Registered Investment Advisory firms adhere to the fiduciary standard 100% of the time.

Compensation Matters

One issue is the way compensation is received by a financial advisor.  Generally, fee-only financial advisors are compensated ONLY by transparent, agreed upon, black and white fees that appear directly on your account statement represented in dollars and cents.  Whereas advisors that don’t adhere to the fiduciary standard are able to be compensated in that same way but in addition, are also able to receive additional non-transparent compensation from the investment products themselves.  This represents a REAL problem!  This compensation is oftentimes not disclosed, is confusing and is frankly, often misleading.  One of the major motivations of the Fiduciary Rule is to get all of the compensation that financial advisors receive out in the open so the average investor can understand what it is they are actually paying.

Is your financial advisor acting in your best interest all the time or only some of the time?  The Fiduciary Rule was intended to make it so you didn’t have to ask this question but unfortunately, it hasn’t yet.

Best Interest Contract Exemption or BICE

For those financial advisors who do receive some or all of their compensation from non-transparent sources, they will now need to engage into a contract with their client called the Best Interest Contract Exemption or BICE.  Most likely, this language will be added to the stack of paperwork you are already required to fill out as an investor.  The Best Interest Contract Exemption will allow the financial advisor to continue receiving compensation directly from those investment products so long as they disclose that to their client at the outset of the relationship and attest to the fact that they intend to act in their best interests for that particular subset of their overall investments.  Be mindful of the fact that it is likely this language will be buried in the stacks of paper an investor signs when they begin a relationship with a financial advisor.  I mean, how often do we really read every word when we sign documents like when we buy a house etc.  From that point forward, since the compensation from investment products is non-transparent, it will continue to be out of sight out of mind.

Non-retirement accounts

The Fiduciary Rule was sponsored by the Department of Labor (DOL), not the SEC or any other regulatory agency.  Upon first glance, it may seem a little odd that the DOL is the agency sponsoring the rule.  It’s intention is to protect employee’s retirement accounts whether they are 401ks, IRAs etc.  After all, most 401ks are sponsored by employers and in order to make IRA contributions, you have to have earned income.  That being said, non-retirement accounts such as brokerage accounts, non-qualified variable annuities etc. don’t fall under the scope of the rule.  Many financial advisors can continue to offer merely suitable suggestions for the dollars you have invested in these types of accounts.

There are over 300,000 financial advisors in the U.S. and most are really brokers that receive non-transparent compensation from investment products.  There are 30,000 or so Investment Advisor Representatives that are part of independent Registered Investment Advisory firms, and that’s great!  But…most of them are part of Registered Investment Advisory firms that are dually-registered.  This basically means they have the ability to be fiduciaries some of the time but not at other times.  In other words, for some accounts and for some clients, they may be a fiduciary but for others, they may not.  They may even be a fiduciary for a client on some accounts but not for others.  Oak Road Wealth Management is a Registered Investment Advisory firm and is NOT affiliated with a broker-dealer.  Our financial advisors are part of a small group of advisors (5,000 or so in the U.S.) that are fee-only ALL THE TIME.  Again, this means we are fiduciaries 100% of the time.  The ONLY compensation we receive appears as a line item on your account statement and is represented in dollars and cents!

Dealing with Conflict

There has been some lashing out toward fee-only financial advisors in retaliation for shedding light on the suitability standard in the brokerage industry.  The claim that has been levied against fee-only advisors is that there are conflicts of interest that are inherent in our way of doing business as well.  Well, that’s actually – true.  One conflict that arises is that most financial advisors are partially or completely compensated as a percentage of the dollars that they manage.  A situation could arise where an investor has the choice between say, paying off their mortgage or investing those dollars with the financial advisor.  In that scenario, a financial advisor would receive more compensation if their client invested those dollars, as opposed to paying down their mortgage.  Another conflict could arise when an investor has a choice between keeping their investment dollars in a 401k or rolling them over into an IRA that the financial advisor manages.  Again, in most cases, the financial advisor gets compensated on the IRA and not the 401k.  

The reality is that conflicts of interest can arise in nearly any type of arrangement with a financial advisor.  That doesn’t mean that the financial professional will give bad advice, it merely means there is the possibility of a conflict.   That being said, these are the things that are important: It’s important that the cost of financial advice is transparent and easy to understand and that investors work with a financial advisor that commits to being a fiduciary ALL THE TIME.

I hope you can see that even with the enactment of the Fiduciary Rule, or with any other rule for that matter, it is incumbent on the investor to do their own due diligence and make sure their financial advisor is ALWAYS acting in their best interests.  And even then, if financial advisors are fiduciaries 100% of the time, it’s impossible to eliminate all potential conflicts of interest.  My opinion is that fee-only Registered Investment Advisory firms like Oak Road Wealth Management that act as fiduciaries 100% of the time, are the best options for investors to get the least conflicted advice.  Beyond that, ask lots and lots of questions, be engaged and take ownership in your investing process.

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