Focus on Fiduciary

What do you think about when you hear the words “financial advisor”?

High pressure sales techniques, obscure products with hidden fees, secret incentives to agents – the list is long and rather unflattering. How did we get here? And, more importantly, how can you choose the right professional to partner with if you don’t want to undertake managing your own money?

In the industry known for its complexity, the terms that describe advisors don’t exactly help you get a sense for the landscape. You have probably heard about “suitability”, “fiduciary standard” and “fee-only model” before but making sense of it all can be tricky.

Here’s what you need to know.

Suitability and fiduciary standards: how are they different?

The best way to explain this is by following the money.

Being a financial advisor is a job, and without getting paid the professional could not continue to deliver the service. While there is nothing wrong with getting paid, the core relationship between the professional and the client can impact your experience as a client, your outcome, and the professional’s paycheck.

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Consider a typical fee-based advisor that works for a large broker-dealer (think Fidelity or Charles Schwab) or wirehouse (think Merrill Lynch). The advisor (or representative) is paid a salary plus commission based on his or her performance. No one wants large enterprises to sell inappropriate products to clients, so broker-dealers and wirehouses are subject to what’s known as a “suitability standard”. In other words, the advisor’s recommendations must be consistent with the best interests of the underlying customer.

That sounds pretty good until you consider that the representative’s first loyalty is to his or her employer, not the client. The recommendation does not have to be the best, least expensive, or most transparent – just suitable. It does not matter if the rep received a higher commission for recommending a product that’s just a “good enough” fit for the client. As long as the rep reasonably believes that the recommendation is suitable for the client’s circumstances, the standard of suitability has been fulfilled.

Compare that with the fiduciary standard of care that requires investment advisors to put client interests above everything else. Through the duty of loyalty and care, the advisor must avoid conflicts of interest, follow best standards for executing advice, and be transparent about fees. All else being equal, the fiduciary standard imposes a higher threshold of duty and offers greater protection to investors than the suitability standard.

At the end of the day, there is nothing wrong with getting paid a commission in exchange for selling more product. Thousands of salespeople make their living that way. As long as the client understands the compensation model and the standard of care, it’s up to the client to choose where he or she buys the product or the service. The problem is that many financial product compensation arrangements aren’t easily discerned or readily disclosed. If a client believes he or she is getting independent and unbiased financial advice, while the professional on the other side of the table is merely selling a financial product, you have a mismatch of expectations.

Suitability and fiduciary perspectives: real-life applications

Illustrating the difference between suitability and fiduciary standards is easiest with an example.

Let’s imagine a family that is looking for a professional to manage its accumulated savings. Husband Sam is 65 and recently retired. Wife Arianne is 61 and a few years away from retirement. Their kids Daniel and Serena are in college. Together, Sam and Arianne have $1M in investable assets. Through Social Security and pension, the family can count on $75,000 of annual income. Their lifestyle calls for a $120,000 annual income in retirement.

If Sam and Arianne were to walk into a local office of a national broker-dealer, they would likely speak with a dual-registered insurance and investments sales rep. After learning about the facts and circumstances of their situation, the rep might have the following options to recommend.

  • A $750,000 annuity that pays a 7% upfront commission to the broker, combined with $250,000 in a bond-centric investment portfolio that pays an average of a 2.5% commission, would take care of all investable assets and generate an immediate $58,750 commission payment to the broker.
  • Alternatively, the broker might recommend a $1M wrap mutual fund account that pays a 2% annual fee to the broker (0.5% quarterly). This option generates a $5,000 fee payment to the broker now, and another $15,000 in the future for the total of $20,000 for the first year. 


Let’s say that either recommendation would be “suitable” under the standard that the broker-dealer representative is subject to. Sam and Arianne don’t know about the commission structure because they did not think to ask the question.
Because of the compensation structure, the rep must choose between two options that result in vastly different payouts for him. Should he select the investment mix that pays him $58,750 right now – or one that only delivers $20,000 over the first year? You can see that there is pressure to recommend investments that pay the representative better, no matter how well-intentioned the professional might be.

Compare that to what might happen if Sam and Arianne choose to consult with a fee-only investment advisor that’s subject to the fiduciary standard. The advisor is transparent about the fee he charges (1% on all assets under management). The annual fee for the investment management service on $1M in investable assets is $10,000 no matter what investment mix is recommended. This allows the advisor to construct a portfolio that meets the best interests of the client’s family. There are no hidden charges or pressures to recommend the “favor of the month” insurance product that pays higher commissions.

Is a fiduciary advisor right for you?

Although the choice of a fiduciary advisor is great for many people, it isn’t automatically right for everyone.

If you are very fee-conscious, you may find that a robo-advisor (an automated advice platform like Betterment or WealthSimple) delivers investment management at a lower cost than a human advisor. If you choose this path, you can expect a simple digital onboarding process, a risk assessment questionnaire that will determine your recommended asset allocation, and the convenience of 24/7 access. This is a practical option for those who have a simple financial situation and are just starting out with investing.

If you want a specific insurance product as part of your portfolio, you may be able to get it through some fiduciary advisors (but not through a fee-only advisor because we cannot accept commissions of any kind).

However, if your ultimate goal is to partner with a professional who will hold your interests above his or her own, a fiduciary advisor is a good choice. The higher standard of care means that the advisor can focus on advice, not product sales. Advisor compensation is transparent. There are no conflicts of interests. And you, as a client, can know that you are getting independent and well-informed financial advice that will adapt to your changing circumstances.