What is this whole fiduciary thing and why is it important?
Overhear the word “fiduciary” from across the room and you might think someone’s throwing around off-color insults. The Urban Dictionary definition isn’t exactly a term of endearment, but the real meaning with regard to your finances is pretty simple: A fiduciary is someone that is working for YOU and puts YOUR best interests ahead of their own (or their firm’s), at all times.
Believe it or not, this is not a requirement for the vast majority of the big brand name institutions in the financial services industry. Nearly anyone can call themselves a financial advisor in some form or another, but that doesn’t mean the “advice” they are providing is anything but conflicted. And what does this mean to you? It means money in the form of fees going into your advisor’s pocket instead of your portfolio.
You may have heard about the latest update to the fiduciary rule, released last week by the Department of Labor (“DOL”). It’s been anticipated for quite some time now and has had most of the industry pretty freaked out that they may have to change their entire business to start acting in their clients’ best interests. For Registered Investment Advisor firms like blooom, which always has been and always will be a fiduciary, a stricter standard on the industry as a whole was something we were pretty excited about. After all, one of the reasons our founders created blooom was to disrupt the industry and shine a light on the largely ignored segment of our population that truly needs non-conflicted advice from someone they can actually trust.
Good or bad, the end result of the new DOL rule thus far has left the non-fiduciary side of the industry breathing a huge sigh of relief, and even popping champagne I would imagine, since the rule is not nearly as strict and comprehensive as originally intended. But regardless of the impact the new 1,000+ page rule (yawn) will or won’t have on the industry and you personally, the good news is that all of this shines a bright light on a pretty important problem and a question that every investor must ask before trusting any professional with their hard earned money – How do I know my advisor is truly looking out for me and my family?
Here are three of the biggest questions to ask of anyone handling your money:
1. How are you compensated?
This should be a pretty simple, short answer: fee-based. Fees can be complicated, especially for non-fiduciary advisors. If you’re hiring someone to manage your investments, they should be charging a simply stated management fee and not making commissions of any kind. Your safest bet when it comes to finding non-conflicted advice is to simply avoid a firm that has their own investment products.
For example, you may have seen a catchy Super Bowl commercial or an ad on the side of a bus for ACME Funds or Jo Schmo Investments. They most likely have their own products like mutual funds or annuities. One may be called ACME US Large Cap Growth Fund and chances are pretty good that if they’re going to recommend that you own some US stocks, they will steer you into that fund. They will most likely have a bias and will be making additional money for getting you to invest in their own products. The advisor may receive commission up front for the transaction and the firm will receive an ongoing fee that is hidden within the price of the fund itself.
2. Do you work for a Registered Investment Advisor (fiduciary standard), a Broker-Dealer (suitability standard), or both (worst of the worst)?
I’ll spare you all the boring detail here, but if you’re interested in a solid explanation from one of our Co-Founders, Kevin Conard, check out this video where we break down the term fiduciary for you:. For the short version – an RIA is a fiduciary and anyone working for an RIA is required by law to put their client’s interests ahead of their own. A Broker-Dealer is a firm that likely sells their own products or makes money for selling specific products for other firms. Although they may also call themselves advisors, they are only required to provide “suitable” aka “just meh” advice. This means they may make sure you’re in the right types of investments like stocks and bonds, but when it comes to selecting the specific products to get you there, they will most certainly steer you in the direction that benefits them (high cost funds, commissions, etc.).
And believe it or not, some firms can actually say they are a fiduciary, but still can throw up red flags. Firms can register to essentially wear both hats. They can be an RIA and a Broker-Dealer, which lets them pick and choose which hat they wear depending on the situation. If you ask if they are a fiduciary, they will simply put their RIA cap on and shout a proud “Of course!”. Pretty awful, I know.
3. Do you separate custody?
Think Bernie Madoff here. You don’t want the person you’re trusting to manage your money to physically be holding onto your money at the same time. Trustworthy advisors completely separate custody of assets so that their client’s accounts are actually held at an independent firm. This is important because it adds an extra layer of accountability and oversight. It also means your advisor cannot do whatever he or she wants with your money. Seems like a pretty reasonable expectation to have right?
I think it’s important to make very clear that the point here is not to broadly paint all non-fiduciary financial professionals as bad people. That’s not the case at all! In fact, there is an important place for brokers and the products that they sell. And most people working in a non-fiduciary capacity are simply trying to survive in an industry that requires them to make the most money they can for their company, or get kicked to the curb. While government may never be able to solve these problems and restore trust in the financial services sector, that doesn’t mean that the average investor has to continue to be left in the dark. Knowing the answers to these few questions can make all the difference in the world when it comes to your long-term success as an investor and simply being able to sleep at night.
And if you just can’t contain your excitement to dive deeper into the specifics of the new 1,000+ page DOL rule, here’s a link to a slightly shorter version directly from the Department of Labor: DOL Fact Sheet. Have at it!