If you are looking for someone to help manage your financial portfolio, it helps to know a bit about how the financial advisor world works before you delve into any money management strategies. Before you hand over control of your hard-earned money to someone, you want to be sure that he or she is acting in your best interests. Unfortunately, this is not always the case. Therefore, it’s important to know about the differences between financial advisors before you can assess if you really need one.
The concept of fiduciary duty become a bit more important when the Department of Labor released their Fiduciary rule in April of 2016. Eventually, the Biden administration released an updated version in February of last year. The rule was significant because it divided the world of financial advisors into two separate halves: fiduciaries and nonfiduciaries.
Regrettably, this distinction probably only added confusion instead of clarity for private investors. Most people are probably unaware that anyone can designate him or herself a financial advisor. There is no legal definition of the term, nor is there a set of standards to which the advisor is bound. The truth is that only financial advisors who are fiduciaries are obligated to act in their clients’ best interests.
What Does It Mean to be a Fiduciary?
A fiduciary is an individual who can act on behalf of someone or something else. In other words, a fiduciary must act as if they are actually the person whom they represent. In addition, a fiduciary is bound to make decisions that are in that person’s best interest. This means that fiduciary financial advisors are held to a higher standard than nonfiduciary advisors.
Fiduciary Standard vs. Suitability Standard
As mentioned above, a person who advises others regarding their finances doesn't have to be a fiduciary. Because of the Department of Labor rule, however, there are now two distinct standards in the financial management industry: the fiduciary standard and the suitability standard.
The difference lies in how a financial advisor makes his or her decisions. Before recommending a financial product, a fiduciary has to determine if it really is in the client’s interest; they must also explain their recommendation and their reasoning thoroughly to the client.
On the other hand, the suitability standard only requires an advisor to have an adequate reason for believing it suits the client’s financial needs. In this case, an advisor really only needs basic information about the investment and their client’s financial situation before making a recommendation.
Conflicts of Interest
Clearly, the suitability standard isn’t nearly as rigorous as the fiduciary standard. Most importantly, it doesn’t require an advisor to put their clients’ best interests ahead of their own. Therefore, it also does not rule out conflicts of interest.
For instance, a nonfiduciary can direct clients towards products that also add to his bottom line, as long as they could be suitable for the client. In contrast, a fiduciary is not permitted to recommend a higher commission product because paying more in fees wouldn’t be in the client’s best interest. While not every nonfiduciary advisor puts their own needs ahead of their clients, it’s important to know that legally, they can.
Whenever you involve someone in your personal financial situation, you are placing an enormous amount of trust in them. For this reason, you should be aware of the differences between financial professionals and their obligations before you start looking for one. Regardless of whom you choose to look after your finances, you must be clear about how they make their money, and the value they can add for the money you pay them.
Do I Even Need a Financial Advisor?
Before hiring anyone to manage to your money, you need to consider if your financial situation warrants their help. Many people think that their money situation isn’t complex enough to justify the services of a financial professional. While this may be true for many people, it is certainly not always the case. In other words, even a relatively straightforward financial portfolio may be overlooking important opportunities to grow wealth and shore up one’s financial future.
One of the added benefits of a financial advisor is that he or she can look at the big picture of your finances clearly because they are not personally involved. Because an advisor isn’t emotionally connected to the situation, he or she has the advantage of looking at everything objectively to figure out how to meet your goals.
Are Advisors Worth the Fees?
This is one of the most important considerations when hiring a financial advisor. While not all advisors make their money the same way, most advisors charge a percentage of assets under management. This can range anywhere from 1% to 1.5% annually. This is significant because your advisor needs to add value over and above their fee to make their services worthwhile. If you’ve paid attention to Warren Buffett over the years, it should come as no surprise how much fees matter to your portfolio over the long term, and how important it is to keep your investing costs as low as possible.
The Financial Benefit
The benefit of using a financial advisor was recently revealed in a Vanguard Alpha study. It found that financial professionals can contribute as much as a 3% net gain over time to a portfolio. Although this may not sound like all that much, a 10% gain vs. a 7% gain in your annual return can make a huge difference in the long term. In fact, even a 2% gain can result in a healthy additional return over time.
The Final Decision Is a Personal One
Moving retirement accounts, changing jobs, or searching for long-term care insurance are just a few of the situations in which people usually need financial guidance. An experienced financial advisor can look at your options and help you plan for your financial future.
In the end, however, the decision to hire a financial professional remains a personal one. You must be completely honest about your current financial needs and your long-term goals, and whether the assistance a financial advisor can provide is the shortest route to reaching those goals.