What is a Fiduciary and Why Does it Matter?

You may hear the term Fiduciary a lot especially when friends and family give you advice on who to choose as a financial adviser. The challenge is that it can mean different things to different people. A fiduciary is a person who is a trustee for someone else’s assets (usually, money). If you work with a CFP professional, the standard is that he/she must act solely in the client’s best interest with regard to financial planning advice.

However, it’s pretty hard to live up to that standard when you make your livelihood off commissions. I would argue it would be near impossible to make your income off selling insurance, as a CFP or any other fiduciary, and only sell the insurance that someone actually needs, which, by the way, is usually the least expensive product (Term Life Insurance), producing the least commissions for the salesperson. It’s a tough standard, and nobody is actively policing it until a possible “wrong” is committed.

Sometimes advisers say they are “fee-only,” usually meaning they are paid by a “wrap-fee.” A wrap-fee is taking a percentage of a client’s assets no matter how well the adviser does or whether the holdings produce a commission or not. A wrap-fee is typically ON TOP of the underlying mutual fund expense ratios and other underlying fees. On the face of it, it seems like the client’s and adviser’s interests are aligned. The Adviser does not care about commissions (good), and makes more money if the client’s assets increase (also, good). Right, but who sets the wrap-fee?

If you have $1 million of assets, and an adviser is charging you 1%, which happens all the time, the client is making a LOT less over the long-haul. To illustrate this, John Bogle, founder of Vanguard, often uses the example: if you invested $1 in an S&P 500 index fund 50 years ago, you’d have $33 today. If you invested the same $1 with an actively managed account (wrap-fee on top of expense ratio, etc.) which is typically about 1.5-2.5% all-in fees, you’d have $11 today. Whose interests are being served? The difference is almost totally based on fees.

What should a regular person do? My advice is to look for the following:

  1. Transparent, consistent fees explained clearly up-front
  2. No conflicts – no commissions or payment for recommending products or services to the client
  3. No wrap-fees or clear pricing for wrap-fees that decreases as asset levels increase
  4. Parameters and guidelines provided for making choices on service providers and always suggesting more than one provider for investment related service providers

As an hourly-paid, fiduciary financial planner, I still make recommendations on things like term life insurance, bank accounts, and of course, investing. Is there any conflict there? Nope, not if the adviser (like me) does not get any financial benefit from making one recommendation over another. Ask your adviser if he/she gets ANY financial benefit from any recommendation he/she makes. If there is any hesitation or murkiness in the answer. Run for the hills!

Bottom line: even if the adviser is a CFP practitioner, or uses the term fiduciary, it’s your job as the client to understand how he/she is being paid. There are no fiduciary police checking to make sure the adviser is truly unconflicted and acting in your best interest, even if the adviser has CFP credentials. You have to be your own advocate and ALWAYS KNOW HOW your adviser EARNS HIS/HER LIVING.