What Is a Fiduciary Financial Advisor?
Financial advisors can help give you money advice, but only fiduciary financial advisors are legally required to act in your best interest.
March 2, 2022
Money can be a confusing topic — some of us may turn to financial advisors for help.
In many cases, this can be a good decision. After all, financial advisors have the expertise, resources and knowledge to point us in the right direction.
It’s important to note though, that there are different categories of financial advisors. One specific type, known as a fiduciary, is required to act in your best interest because of fiduciary duty.
But what does that all mean? What is a fiduciary financial advisor exactly? Let’s start with explaining fiduciary duty.
What is fiduciary duty?
As we mentioned above, a fiduciary financial advisor is required by fiduciary duty to act in their client’s best interest.
Fiduciary duty essentially means that the advisor must recommend products, strategies and services that they genuinely believe will benefit the client the most.
It also means that fiduciaries must avoid conflicts of interest and provide independent advice to the best of their abilities.
Importantly, not all financial advisors are fiduciaries, and there are substantial differences between fiduciary and non-fiduciary financial advisors.
How to tell if a financial advisor is a fiduciary
Advisors often use all sorts of terms and titles to describe themselves. Many of these terms don’t actually have any formal meaning or legal backing.
Terms like “financial advisor” and “wealth manager” are more marketing terms than anything else. So how do you know if an advisor is a fiduciary?
The simplest way to determine is to ask them directly if they are. True fiduciaries will be able to answer in the affirmative without hesitation.
Here’s another easy method of distinguishing fiduciaries: All certified financial planners (CFPs) are fiduciary advisors, because a fiduciary duty is required by the standards of the CFP board.
CFPs are experienced financial planners and advisors who have completed a rigorous certification process.
Advisors who are CFPs will usually have “CFP” next to their names — e.g., John Smith, CFP®. You can also verify online that a professional holds CFP certification.
To obtain CFP certification, advisors must hold a bachelor’s degree, or be working toward one, and must complete extensive coursework on financial planning. On average, CFP applicants spend 12 to 18 months completing financial coursework in addition to their four-year degree.
CFPs must also obtain 6,000 hours of financial planning experience, which is roughly three years of working full time as a financial planner. They must also meet ethics requirements, including a background check and an agreement to follow fiduciary duty.
In short, certified financial planners are required to be fiduciaries, and they also have formal training and ample experience. If you want to work with a well-qualified advisor, finding a CFP is a good option.
Non-CFP advisors can also be fiduciaries, but many are not. You can ask advisors if they follow fiduciary duty to learn more about their approach.
Finally, you can use online search tools to verify the credentials of advisors. The Securities and Exchange Commission (SEC) maintains a database of advisors, as does the National Association of Personal Finance Advisors (NAPFA).
Fiduciary advisors and investment fees
One substantial benefit of working with a fiduciary is that they can often help to minimize your investment fees.
All financial advisors will charge their own client-related fees, but when it comes to the management fees on specific investment products, fiduciary advisors often differ from traditional advisors.
For instance, fiduciaries may recommend lower-fee investments even if that means that the advisor will earn less in commissions.
Let’s say the advisor recommends that you invest some money in a stock-based mutual fund. They give you two available options that invest in identical assets but are managed by different companies:
Fund A has a 0.35% expense ratio and does not pay any commission to the financial advisor
Fund B has a 1.5% expense ratio and pays the financial advisor a hefty commission for each new client he sends to the fund
In this case, a fiduciary would be required to recommend fund A as it’s the cheaper option for you. Remember, the two funds invest in identical assets — the only difference is in the investment fees and the commission that the advisor receives.
A financial advisor who is not a fiduciary may choose to recommend fund B. After all, this would earn them a significant commission.
The impact of fees on investment performance
Is it a big deal if an advisor recommends a fund with higher fees?
As it turns out, yes it is.
Over the long run, investment fees can have a huge impact on your portfolio.
To illustrate, let’s look at an example:
Rohit invests $100,000 into a fund with a 2% expense ratio.
Samantha invests $100,000 into a similar fund with a 0.5% expense ratio.
Both funds earn an average of 7% per year before fees.
Rohit and Samantha leave their funds invested for 30 years and do not invest any additional money.
After 30 years, Rohit will end up with around $498,000, while Samantha will end up with more than $661,000.
This seemingly small difference in fees ended up costing Rohit $163,000 in lost earnings over the course of those 30 years.
It goes beyond fees
Fees aren’t the only thing to keep in mind. Remember, fiduciaries are required to act in your best interest, to the best of their ability.
This means that a fiduciary advisor is required to evaluate your situation, weigh all the options available to you, and recommend the course of action they believe will benefit you most.
For example, investing is a great way to build long-term wealth, but if you have high-interest debt, paying that off before investing often makes financial sense.
A fiduciary would likely point this out, encouraging you to pay down the debt first, even if that means delaying your investing goals.
Fiduciaries vs. standard financial advisors
What is a fiduciary financial advisor compared to a standard investment advisor?
Fiduciary duty is a legal obligation to act in a way that most benefits the client. If a fiduciary fails to uphold this standard, they could face legal consequences.
On the other hand, general financial advisors don’t have any specific legal obligation to act in your best interest. They can’t scam you directly, but they can recommend lower-quality investment products that may cost you more than necessary.
Mastering your money
Now you know what a fiduciary financial advisor is. There’s a lot more to learn about finance whether you work with an advisor or not. Here are some articles to get you started:
You can also sign up for the Tally newsletter to get news and information to help you manage your finances.