What Is a Fiduciary Financial Advisor and Do I Need One?

What is a fiduciary? And how do you know if a financial advisor holds that designation?

In this article, I’ll explain why you want a fiduciary financial advisor and help you understand the standards that fiduciaries are legally required to uphold.

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Why You Need a Fiduciary Financial Advisor

Money expert Clark Howard wants people to do business only with financial advisors who are fee-only fiduciaries. Learn more about what that means and how to find a fee-only fiduciary later in this article.

A fiduciary financial advisor is a person or a company that's legally required to put your interests first.

Believe it or not, some people (often called brokers) are allowed to recommend investment products that will line their pockets even if there are better options for you.

In what some would call the needlessly complicated world of financial advisors, it’s not enough to know the definition of a fiduciary. That’s because “fee-based” fiduciaries can still earn commission by selling you investment products.

If you want to hire a financial advisor who absolutely must do what's best for you and can't make any money via commission, you'll need to go with a fee-only fiduciary financial advisor.

What Is a Fiduciary?

A fiduciary is a person or legal entity that has the power to act on behalf of someone (often called a “beneficiary”).

Fiduciaries are legally obligated to act in the best interests of their beneficiaries. They must avoid or disclose conflicts of interest. They also must prioritize what’s best for their beneficiaries over their own interests.

The concept of a fiduciary isn’t limited to investment advice. Some other examples of fiduciary relationships include:

What Is Fiduciary Duty?

A fiduciary financial advisor must uphold a fiduciary duty to you. That fiduciary duty legally protects you as a client.

A doctor can’t legally sell you a drug that isn’t best for your condition just because they get a commission from the drug company. According to the law, neither can a fiduciary financial advisor buy and sell investment products on your behalf that aren’t good choices for you.

Financial advisors provide a range of services. A client’s relationship with a financial advisor can be ongoing or it can be a one-time consultation.

Regardless, fiduciary financial advisors can't do these things:

Fiduciary Standard vs. Suitability Standard

Financial advisors, sometimes called wealth managers or financial planners, can be divided into two main categories: fiduciaries (or “Registered Investment Advisors”) and broker-dealers.

A fiduciary financial advisor is subject to the Investment Advisers Act of 1940. That federal legislation requires fiduciaries to register with the Securities and Exchange Commission (SEC) or at least with the state in which they do business, depending on how much money they manage.

The Investment Advisers Act also stipulates the legal requirements that fiduciaries must follow.

The second category of financial advisors, broker-dealers, are people or companies that buy and sell securities such as stock on behalf of their customers.

The negative view of broker-dealers says they’re just salespeople or order takers. Some of them are independent and offer a large selection of products and services. However, some broker-dealers work for specific companies and make commission when they get people to buy.

The Financial Industry Regulatory Authority (FINRA), regulates broker-dealers. (It's a private nonprofit corporation that's authorized by the SEC.) FINRA requires broker-dealers to have "a reasonable basis to believe" that the products they recommend are suitable for their clients. In practice, that's a much lower standard than the one that fiduciary financial advisors must meet.

Historically, broker-dealers weren't required to put your interests over their own or even avoid conflicts of interest. There's an ongoing legal back-and-forth that has created a stronger standard for broker-dealers, although it's unclear whether that will last.

Prior to this new development, there was legal room for a broker-dealer to recommend a product that earned them a higher commission but wasn’t necessarily the best for you as long as the investment was “suitable.”

How To Know if a Financial Advisor Is a Fiduciary

It’s much more difficult than it should be to verify that a financial advisor is a fiduciary.

Fiduciaries and non-fiduciaries have gotten into legal battles about who gets to call themselves financial “advisors.” Sometimes it can be unclear whether someone is a fiduciary or a broker-dealer.

“There are a number of professional designations now that are a series of initials that people think makes somebody a safe zone for them to invest with,” Clark says.

“But the reality is, if they’re not legally bound via fiduciary, it’s a no-go. Because the danger is that they recommend stuff that makes them money at your expense.”

One way to make sure that you're working with a fiduciary is to work only with a Certified Financial Planner (CFP). That's an earned designation that, among other things, requires being a fiduciary. You can verify whether someone is a CFP on the CFP Board website.

You can also look for a financial advisor near you through the Garrett Planning Network, which requires its advisors to be fiduciaries.

Usually, you can start to figure out whether someone is a fiduciary financial advisor by asking them how they get compensated. You can ask them how they get paid and whether they make money through commissions.

Compensation Models for Financial Advisors

Clark strongly recommends that you work only with fee-only fiduciary financial advisors.

Fee-only fiduciaries get paid in one of three ways:

Fee-only advisors have no financial incentive to put you into investments and products that benefit them. Their compensation is independent of the investments they recommend to you.

In fact, they may be incentivized to ensure your portfolio performs as well as possible. The more your assets grow, the more money they may make, especially if they charge a percentage of AUM. (Most financial advisors base your annual fee on your AUM at the beginning of each year.)

Fiduciary financial advisors are required to provide their services on a fee-only or fee-based basis. Even though the terms are similar, there's an important distinction. An advisor who gets paid through one of the three fee models I listed above and receives a commission on sales is considered to be fee-based.

As long as a fee-based financial advisor discloses any conflict of interest, it’s possible for him or her to be a fiduciary and still earn commissions. Those disclosures can be in fine print that some people are unlikely to read.

That’s why Clark says to always work with fee-only fiduciaries.

Broker-dealers can be compensated on commission or per transaction. Historically, they’ve had to meet the suitability standard, but it’s legally possible for them to provide investment advice that isn’t the best for you. They may earn more money by getting you to complete more transactions or invest in products they’re paid to sell.

What Is Regulation Best Interest?

Approved in 2019 and effective as of June 30, 2020, Regulation Best Interest — or "Reg. BI" — is an SEC rule under the Securities Exchange Act of 1934.

It requires broker-dealers to recommend only those investments in their clients’ best interests, which is a higher standard than FINRA’s “suitable” rule. (Remember, broker-dealers tend to be commission-based.)

“Reg. BI” is a fairly demanding law, at least on paper. It includes language requiring investments to be in the best interest of the client “at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer.”

However, there appear to be some loopholes in the law. In the end, it may serve only to muddy the waters for customers not equipped to figure out the small but significant differences between advisors.

As of February 2021, it isn't clear what stance that President Joe Biden will take on this legislation. Some are hoping he replaces it with an even stricter law, while others think Reg. BI goes too far.

“Why not just require people who advise you on your money to be fiduciaries, period? That’s what they should be doing,” Clark says.

There are also ongoing negotiations involving the U.S. Department of Labor rule that regulates fiduciary financial advisors under the Investment Advisors Act of 1940. It’s a reasonable expectation that the federal language and rules may change, but you are doing all you can to protect your investments if you follow Clark’s advice and (let’s say it one more time) work only with a fee-only fiduciary financial advisor.

Is a Robo-Advisor a Fiduciary?

Many robo-advisors are legally registered as fiduciaries.

New technology usually raises questions about how the old rules apply. That’s true with the fiduciary designation and robo-advisors.

Let's back up for a second. In case you aren't familiar, robo-advisors are algorithms that invest your money in pre-built, diversified portfolios based on things like risk tolerance, age and income.

A number of robo-advisors are registered as investment advisors with the SEC. However, robo-advisors are limited in scope. They provide investment guidance. But they generally don’t offer retirement planning, debt management, tax strategy and estate planning, which are common to full-service financial advisors.

Some have questioned whether the fiduciary designation should apply to limited-scope auto-investing.

Do I Need a Financial Advisor?

With all this talk about fiduciary financial advisors, it’s easy to forget that not everyone actually needs a financial advisor at all.

If you’re 20+ years away from retirement and/or you don’t have enough money invested to start determining your retirement and estate plans, you most likely don’t need a financial advisor — at least not on an ongoing basis.

Clark says the most important thing, if you're in the "accumulation" phase of saving and investing, is to get used to putting money into the market. Get more of Clark's tips on how to start investing here.

Still not sure whether you need a financial advisor, a robo-advisor or if you should manage your own investment portfolio? Read this for an even more detailed answer to this question.

Final Thoughts

Keeping track of the latest legal nuances for financial advisors isn’t in the cards for most people.

That’s why it’s important to work only with fiduciary financial advisors — preferably fee-only Certified Financial Planners. That way you know that your financial advisor will be legally required to put your interests above their own and won’t be incentivized to sell you any specific products.

If you’re trusting someone with your money, and important life milestones like retirement, make sure that person is obligated to work in your best interests.

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