The reality is...NOT ALL FINANCIAL ADVISORS ARE CREATED EQUAL.
If you are like most people, you're probably confused by the long list of advisor titles i.e. financial advisor, financial consultant, wealth manager, investment consultant, or financial planner just to name some of the more popular ones. That's not to mention trying to sort out the alphabet soup of credentials after the person's name.
I'm going to open the kimono of the financial industry & tell you a little secret...something CRAZY!
ANYBODY can call themselves a financial advisor! Insert one of my favorite 15 second commercial breaks from the CFP Board.
Unfortunately, the term "financial advisor" has become a generic term that has no precise meaning whatsoever. Just because someone calls themselves a "financial advisor" does not mean that he or she has any specific education, background, experience, or certification which actually qualifies them to give financial advice. What makes this especially unfortunate is that the most common usage of the term "financial advisor" nowadays is for a salesperson. Stockbrokers and insurance agents, especially, call themselves "financial advisors" all the time. This can be very misleading.
Now this may seem like a silly question but when it comes to your financial future, would you rather have someone who is legally obligated to act in your best interest, or someone who can, but is really only obligated to give you "suitable" advice?
Suitability vs Fiduciary
So what's the difference?
If you're financial advisor is operating under the "Suitability" standard of care...they “must have a reasonable basis for believing that the recommendation is suitable for you.”
If you're financial advisor is a "Fiduciary"- they have the legal and ethical duty to act solely in your best interest. The fiduciary duty is the strictest duty of care recognized by the U.S. legal system.
This may not seem like a big difference, but it is HUGE. Michael Kitces analogy says it best, “Suitability means selling a sweater that fits you. Fiduciary duty means it actually has to look good on you, too”. After all, we all know that when the car salesman says “I have the perfect vehicle for you”, the “advice” should be taken with a grain of salt and is different than consulting with a professional like a doctor, attorney, or accountant.
If this is all new to you, you are not alone. J.D. Power and Associates found that 85% of investors have either not heard of or do not understand the difference between the suitability & fiduciary standard.
Watch Out For The Hat Trick
To make things even more confusing on the consumer, a financial advisor can actually be BOTH. Yes, your financial advisor may serve as a fiduciary for some transactions and "switch hats" to act as a broker on others (subject only to the suitability standard). Sounds crazy, but it's actually very common. According to a FINRA study, 88% of investment adviser representatives are also registered as brokers. These are what we call dual registrants. They can engage in "hat switching," serving as a fiduciary on one transaction and a broker on another.
Fee-Only vs Fee-Based
This leads me to the next topic of fee-only vs fee-based. Fee-only advisors are fiduciaries. Fee-only advisors cannot legally accept commissions and their only source of revenue is the fee they charge for advice and investment management. Since brokers are commission oriented, they cannot legally hold themselves out as fee-only. “Fee-based” however is a very different story. A “fee-based” advisor offers advisory accounts as well as brokerage accounts and is a dual registrant.
Personally, I believe it's unconscionable that all advisors do not operate according to a fiduciary standard.
This isn't just my view. The problem became so large and widespread that the U.S. government has stepped in to try and fix the situation. In February 2015, President Obama directed the Department of Labor (DOL) to propose rules that "requires retirement advisors to abide by a ‘fiduciary’ standard – putting their clients' interests before their own profits." According to the DOL, "A White House Council of Economic Advisors analysis found that these conflicts of interest result in annual losses of $17 billion/year."
Even personal finance guru, Suze Orman weighed in on the matter in recent Forbes article saying "It really boils down to 5 words: someone who doesn't sell products. The most important tip is to ask how the advisor is being compensated".
In summary, no matter which advisor you choose, make sure you understand whether financial advisor is held to the "fiduciary" or "suitability" standard of care as well as how they are compensated. To be fair, there may be times where commission based accounts sometimes are appropriate for small balance accounts or accounts that don't trade much.
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Desmond Henry is a fee-only CERTIFIED FINANCIAL PLANNER™ professional and founder of Afflora Financial Life Planning in Topeka, Kansas. He helps the retiring/retired plan their finances and invest their money. CLICK HERE to learn more.