When you’re choosing how to invest, you have lots of options. From working with a traditional brokerage to a personal financial advisor, to even just using one of many publicly available research and investment tools, individual investors have never had this many choices when deciding where and how to invest their money. However, many investors don’t realize that different investment choices come with other obligations and incentives. In many cases, how you choose to invest can be as important as what you invest in.
One concept that new investors may find themselves encountering for the first time is the concept of a “fiduciary” advisor. Understanding what the term fiduciary means, what a fiduciary financial advisor is, and how the fiduciary duty impacts your investment portfolio is a crucial early education for new investors.
What Is A Fiduciary?
Legally, a fiduciary is a person or entity that owes a duty to put their clients’ interests (in many cases) ahead of their interests. Fiduciary duties show up in many different contexts in which individuals and organizations find themselves in relationships requiring total trust, good faith, and honesty. Some familiar fiduciary relationships include the attorney-client relationship, the duty of corporate officers to put the corporation’s interests above their interests, and the obligation of fiduciary financial advisors to fulfill their duties of care and loyalty to their clients.
Fiduciary Financial Advisors
Not all financial advisors owe their clients a fiduciary duty. Some, including broker-dealers, owe no ongoing fiduciary duty to make investments or sell securities in their clients’ best interest. These professionals, who are compensated based on commissions from the investment products they sell, have an obligation to their firm or to the clients providing the commissions, but not to the private investors purchasing these investment products.
For advisors who are fiduciaries, also known as Investment Advisor Representatives or fee-based advisors, and sometimes called RIAs, the obligation to act as a fiduciary to clients comes from the Investment Advisers Act of 1940. The Act provides that financial advisors who are compensated for advising about securities investments, as opposed to simply trading in those securities, must register with the Securities and Exchange Commission and act under regulations promulgated by the SEC. Under the interpretation of those regulations, the fiduciary duty owed by Investment Advisor Representatives includes two main components: the duty of care and loyalty.
Duty Of Care
As interpreted by the SEC, the advisor’s duty of care is simple: an advisor must provide investment advice in the client’s best interest, with the client’s objectives in mind. To meet this obligation, the advisor must consider “the client’s financial situation, level of financial sophistication, investment experience, and financial goals” in providing investment advice. The advisor must make reasonable efforts to ensure that the client’s decision is not based on incomplete or inaccurate information. The advisor must also ensure that the transaction to purchase or sell investment products is executed to minimize the client’s cost and maximize returns.
Duty Of Loyalty
The advisor’s duty of loyalty is an obligation to avoid or disclose conflicts or potential conflicts of interest. As stated by the SEC’s interpretive guidance, “under its duty of loyalty, an investment adviser must eliminate or make full and fair disclosure of all conflicts of interest which might incline an investment adviser — consciously or unconsciously—to render advice which is not disinterested such that a client can provide informed consent to the conflict.”
In other words, an investment advisor’s fiduciary duty requires the advisor to avoid conflicts where possible and to disclose the conflict if it cannot be avoided.
Why Investors Should Work With A Fiduciary Financial Advisor
It may seem like engaging a commission-based broker is less expensive for many new investors than working with a fee-based fiduciary advisor. However, working with a fiduciary financial advisor can provide an additional level of peace of mind, especially for new investors. As a fiduciary, an investment advisor’s obligations are always to put the client’s interests first and ensure that each client’s financial plan is designed to meet those goals best.
A fiduciary relationship also means that an advisor is always looking to complete trades in the most cost-effective way for the client, instead of selling products that earn higher commissions and serve the wirehouse or dealer’s interests. When it comes to comprehensive financial planning, engaging a fiduciary financial advisor means that clients can trust that the advice they’re receiving is always designed to keep their interests in mind.
For most investors, working with a fiduciary financial advisor means that they can develop a financial plan and investment strategy that takes all of their goals into account — instead of merely executing trades. A financial advisor helps clients evaluate their entire financial condition and develop a comprehensive overall strategy that meets all of their goals.
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