You may have heard the debate over “suitability” versus “fiduciary duty” and wondered “What do those things even mean? Does it even matter?” Well I’m here to tell you: It does matter. It determines whose interest comes first: yours or your financial advisor’s.
So first off, what does it mean to have a fiduciary duty? In the simplest terms, a fiduciary duty is an obligation to act in the best interest of another party. A fiduciary relationship is one of complete trust and utmost good faith. In fact, the term fiduciary comes from the Latin words “fiducia” which means trust and “fides” which means faith. A fiduciary is expected to be extremely loyal to the person whom he owes the duty.
Many types of professionals owe a fiduciary duty to someone – for example, lawyers to their clients, trustees to the trust beneficiaries, and a corporation’s board to its shareholders. As an investment advisor, Merriman has a fiduciary duty to its clients. As a fiduciary, we are required to act solely in the best interest of our clients.
It’s something we take very seriously. We look for the best investment opportunities we can find for our clients and avoid investing in products that have extra fees and service charges. It’s the reason why our advisors do not receive sales commissions, and we are not compensated by any outside mutual funds for investing money in their funds.
Unfortunately, advisors who are not fiduciaries are not held to such a standard. It’s perfectly legal for them to put their own interests first, and their interests may be very different from yours. Broker–dealers, for example, currently work under the suitability rule which only requires them to make recommendations that fit the customer’s financial situation and risk tolerance, but doesn’t require them to put the customer’s needs first.
Let’s look at what this means in practice. Suppose that you have two funds to choose from: Fund A, which charges a 5% upfront sales load, or an essentially identical Fund B, which is no-load. In the first case, 95 percent of your money is invested in the fund’s portfolio. In the second case, 100 percent of your money is invested in the fund’s portfolio. Fund B is a better deal for you.
If you are working with a broker, he can sell you Fund A, as long as it’s within your risk tolerance, without breaking the suitability rule. And, he is earning himself and his company a nice commission at your expense!
On the other hand, an investment advisor who has a fiduciary duty would be required to recommend the no-load Fund B precisely because it is the better option for you, even though Fund A would be more profitable for himself and his firm. A fiduciary, as you can see, must put your interest first, and that is something that should definitely matter to you!
Because fiduciaries are held to a much higher standard, it is important for you to seek advice only from people who have a fiduciary duty. Currently there is debate over whether broker-dealers should have a fiduciary duty. We think they should, and hopefully someday soon this will happen. But in the meantime, here are a few questions you should ask someone you are considering hiring as your financial professional:
- Do you have a fiduciary responsibility that applies to the advice you will give me? What does this mean to you and your company?
- Do you sell any products for which you earn a commission or any other compensation that’s not paid by me?
For more ideas, please read our full list of questions to ask when interviewing an investment advisor.