Trust. It’s something that you expect when hiring a professional. You trust your doctor will “do no harm” and keep you healthy. You trust your lawyer will go to the mat to defend your interests in court.
Yet, you might be surprised to know, unlike a doctor or lawyer, your financial advisor is not always required to put your best interests first when offering you financial advice.
You see the financial world boils down to two types of financial professionals; there are those who are fiduciaries and those who are not. Why does this matter? A fiduciary has the responsibility to put your interests before his own.
A non-fiduciary, however, is only required to offer financial advice and investments that are “suitable” but not necessarily “optimal” for their clients. This is a huge distinction because many financial professionals are compensated by the commissions they receive from the mutual funds and other financial products their clients purchase.
Let’s see how these two types of financial professionals (fiduciary vs non-fiduciary) might approach your financial situation differently.
Example 1: You need help in planning how to spend a $12,000 inheritance. A non-fiduciary might propose one of several mutual funds for your new windfall. The non-fiduciary of course would receive a commission from each mutual fund you enrolled in.
A fiduciary, however, might dig further and discover that you have nearly $11,000 in high-interest credit card debt with an annual interest rate of 18 percent. Her suggestion to you might be to pay down this debt first before you invest, which would guarantee you a return of 18 percent, by far the smarter financial move.
Example 2: You want to invest for retirement. A non-fiduciary might once again encourage a high fee, poorly performing mutual fund or an annuity that doesn’t meet your needs because these financial products provide him with higher commissions.
A fiduciary, on the other hand, might steer you toward a low fee index fund that tends to outperform actively-managed mutual funds over the long term.
According to the White House, such conflicts of interest, which are inherent to the way non-fiduciaries are compensated through commissions, cost consumers nearly $17 billion each year.
NOTE: The Obama administration is currently supporting a proposed Department of Labor rule that would require more financial advisors to act as fiduciaries when advising their clients. As you would expect, the financial industry and Republican-controlled Congress is pushing back vigorously against the new rule.
Regardless of whether or not the fiduciary rule is enacted there is one thing you can do to protect yourself. Always ask any prospective financial advisor whether they are a fiduciary. If they are not a fiduciary, then consider finding another advisor or, at the very least, ask them to reveal any potential conflicts of interest that might arise during your relationship.
BMWK, who are you trusting with your money?