Fiduciary Definition

Fiduciary Definition

6 min read

What is the fiduciary definition? At a high level, a fiduciary is a person or organization that acts on behalf of another person or persons. They must legally and ethically put their client’s interests ahead of their own. Overall, they must preserve trust and act in good faith. When a party knowingly accepts a fiduciary responsibility on behalf of another party, they must operate under the prudent person’s standard of care.

In simple terms, a fiduciary is like a money manager. However, they must look after your money for your benefit, not theirs.

  • Not all investment managers are fiduciaries.
  • Under the law, fiduciaries must put your needs ahead of their own.
    no profit is to be made by the fiduciary from the relationship
  • Not all fiduciary financial advisors are the same
  • Most money managers in the US are duly registered as both a broker and fiduciary? Be careful.

Fiduciary Definition of Questions A Fiduciary Asks Themselves Before Making A Decision On Behalf Of Their Client

  • What are my client’s goals?
  • What does my client need?
  • Is this decision in the best interest of my client?

A Lot Of Money Managers Are Not Fiduciaries

Remember that not all types of fiduciaries are equal – there are four types of fiduciary financial advisors. Therefore, asking your money manager if they are a fiduciary is imperative. This is important because large companies employ many money managers. And these large companies require them to put their clients only in funds the company supports. In other words, funds are in the best interest of the company. 

Other money managers look for investments with large commissions to get a big fat commission check. Then they put the client into that product that’s not necessarily good for the client.

All of this matters because if you don’t have a fiduciary money manager, you could get put into something that won’t help you. You could lose money.

Fiduciary Definition

Other Types Of Roles That Must Act In Good Faith

If you go to any country, doctors and lawyers must put your needs first. In other words, they must act in good faith. For example, doctors can’t order tests, so they make more money. Lawyers, guardians, and executors of wills are other roles that must act in good faith. 

In the US, fiduciaries are called IAS registered investment advisors. So if they tell you to buy Apple this morning, and they buy Apple tonight, and they get a better price, they have to give you their stock. That’s how strong the law is. But, sadly, that is not true for every broker.

A Startling Fact

Did you know that of the 31,000 people that have to put you first, 26,000 are duly registered? What this means is that they’re both a broker and fiduciary. That’s concerning as broker-dealers have to meet less-stringent suitability standards. This means they don’t have to put the client’s interests ahead of their own. That’s concerning.

You don’t go into a barber shop asking if you need a haircut or a butcher shop asking if you need meat. So what do you think their answer is going to be? Of course, it’s a yes! That’s why I suggest going to an independent registered investment advisor.

A Real-Life Example Of A Fee-Only Fiduciary

Let’s say one of your goals is to retire at 45. To do so, you’ve decided you need someone to help you structure your portfolio. So, on a glowing recommendation from a friend, you select Janet, an investment manager and a fiduciary. What this means is that Janet will invest according to your needs. 

So, her first step is to structure your portfolio with the proper balance of real estate, stocks, and bonds. She gets paid an hourly rate and not commissions on the products she sells you. 

Fiduciary Definition: Broker-Dealers & The Suitability Requirement

Typically, broker-dealers receive their compensation by commission. However, as I mentioned above, they must only fulfill a suitability obligation. Therefore, even though FINRA regulates broker-dealers, they only have to believe their recommendations are reasonably suitable for the client. Always remember, the broker’s primary duty is to their employer, not you, the client. 

In some cases, you see them engaging in excessive trading and frequently shifting account assets to generate commissions on transactions. But, even more, concerning is that they don’t have to disclose potential conflicts of interest. 

The Fiduciary Standard vs. The Suitability Requirement

Under the fiduciary standard, your investment advisor cannot buy a mutual fund when the client has cheaper options. For instance, the actively managed mutual funds that many non-fiduciaries recommend have a sales charge ranging from 4% to 8% after selling and buying. To rub additional salt in the wound, you’ll pay an extra 1% to 2% a year in management fees with an actively managed fund.

Under the suitability requirement, as long as the investment suits the client, they can buy it. The key point is that this can incentivize brokers to sell their products first despite cheaper products on the market.  

The Independent Registered Investment Advisor

There’s no incentive for an independent registered investment advisor to sell you anything. They get a  fee for what they do. And the difference could mean hundreds of thousands of dollars, if not millions, at stake. On the other hand, you will find that many fiduciary retirement advisors offer less biased products. Take passively managed funds, for example; this charge only a small management percentage, ranging from 0.1% to 0.2%.

Depending on the advisor and broker, I’ve seen differences between 0.5% and 1.5% in fees. 1.5% may not sound like a lot, but here’s where things get interesting. Let’s say you retire with a million dollars and your money growing at 7% per year at both advisors—equal growth.

Over 30 years, the difference in fees over 30 years for that person ends up being $1.6 million in favor of a fiduciary financial advisor, who is less expensive.

Questions To Ask When Selecting A Fiduciary Financial Advisor

  • Who pays you?
  • Who will manage my investments?
  • What is your track record? Request a copy of Form ADV, which discloses potential conflicts from securities trades.
  • Are you legally bound to act in my best interest?
  •  Are you acting as a fiduciary?
  • If you are not a fiduciary, what’s your fee structure?

The Bottom Line

The fiduciary definition bottom line is to recognize that many different types of people are willing to manage your money. But, not all of them are fiduciary financial advisors. Just saying you’re a fiduciary doesn’t clarify what their obligations are or not. Fiduciary duties can vary. Please clarify their scope, if they’re registered as a broker, and where their interests lie. 

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