Did you realize that not all financial advisors are obligated to act in your best interest? Financial professionals are obligated to offer products and advice that are suitable for your needs, but not all of them are obligated to offer the best advice possible.
Two standards govern financial advisors – the fiduciary standard and the suitability standard. Under the fiduciary standard, a financial advisor is legally obligated to give you the best advice for your situation, even if it's not in the advisor's best interests. Under the suitability standard, advisors must give you advice suitable for your situation but may still act in their own best interests.
To illustrate the difference, consider shopping for an appliance. When you describe your needs, the sales clerk may have a model that works but know that the best appliance for you is sold at a competitor across town. Under a fiduciary standard, the sales clerk may offer their product but must tell you about the better product across town. Under a suitability standard, the clerk may offer an appropriate option to meet your basic requirements – but there's no obligation to tell you about the better product.
The Obama administration planned to close this obligations gap with the Fiduciary Rule issued by the Department of Labor. Under the Fiduciary Rule, all financial professionals were required to meet the fiduciary standard – ensuring that all consumers received conflict-free advice, regardless of the size of their account. According to initial estimates, consumers would save $17 billion annually as a result.
Many in the financial industry objected, citing excessive costs. Critics argued that maintaining a fiduciary standard would limit the availability of suitable investments for small investors – ultimately hurting the consumers the rule was designed to protect.
We'll never know who was right. The Trump administration delayed implementation of the Fiduciary Rule, and the U.S. Court of Appeals (Fifth Circuit) recently struck down the law before it could be implemented.
There's been some positive impact from the mere threat of the rule. According to Morningstar, average mutual and exchange-traded fund fees dropped by 8% in 2017, the largest decline in year-over-year terms ever noted by the firm. Financial products had already adapted to the new rule, saving $4 billion in collective expenses.
With the fiduciary rule officially dead, it's up to you to find out what standard your broker or financial planner uses. Ask pertinent questions. Is the financial advisor claiming a fiduciary standard, and does that fiduciary standard apply to all services? Check credentials and ask them to explain what a fiduciary standard obligates them to do for you.
Ask how the advisor is compensated. Fiduciaries are compensated based on fees that are unrelated to the investments they suggest. Fees may be hourly rates, flat fees, or as a percentage of the account assets. Advisors operating under the suitability standard are often paid on commission, giving them major incentive to recommend the investments they represent.
It's fine if your broker or advisor isn't a fiduciary but understand that the financial expert is only obligated to find a suitable financial product for you. The best deal for you may lie with competitors, but the advisor is not obligated to tell you that.
If you're diligent, the fiduciary rule changes shouldn't make any difference at all. You should ask your advisor similar questions even if the fiduciary rule were still around. The key is to make sure you're getting the advice you need with a financial professional whom you trust, and under terms and conditions that you fully understand.
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