Who gives you financial advice and why does it matter how he or she is paid? Compensation matters because it’s probably the most important thing determining the quality of advice you receive. The SEC has been studying the concept of “fiduciary responsibility” because billions of dollars are at stake, and most consumers and investors remain confused how their advisor fits into the regulatory regime. Can you answer these questions? • What are the differences between brokers, insurance agents, and “financial advisors”? • What’s the difference between “Fee-Only” and “Fee-Based”? (Hint: They sound alike but they’re quite different.)
Here’s a brief guide to help untangle these concepts. Brokers and insurance agents: Brokers and insurance agents can sell financial products (mutual funds, annuities, variable life insurance, annuities). Their standard of fiduciary care is a “suitability” standard. This standard of care means they are legally allowed to benefit more from product sales than their client benefits— as long as their products are very broadly considered to be “suitable” for that client. Not optimal, just suitable. Advisors and financial planners: This term is confusingly broad—some advisors have no designation, but others have earned designations such as CFA, CFP®, ChFC®, or CPA/PFS. There are dozens of designations in financial services, but those four are widely acknowledged to require a substantial amount of study in order to pass exams and an adherence to standards of oversight.
Advisors who sell products can hold any of the above-mentioned designations. Many of these advisors operate with “Fee-Based” compensation, which means that advisors can earn compensation from fees paid directly by clients PLUS fees they receive in the form of commissions or discounts from products they’re licensed to sell. Most are not required to inform their clients in detail how their compensation is accrued. I say “most” because CPAs in Washington State are specifically required to disclose all forms of compensation regardless of what other designations they hold. Fee-Only advisors, by contrast, do not sell any financial products. If their clients need products (e.g., insurance), they work with professionals they trust, but the advisor does not receive a split of the fee with the insurance agent. There is no inducement to the advisor for the sale of products. Fee-Only advisors typically charge a percentage of investments they manage or charge by the hour or through a retainer arrangement. Conflicts of interest are kept to a minimum with this fee structure.
The Critical Issue of Fiduciary Standards. An advisor held to a fiduciary standard occupies a position of special trust and confidence when working with clients because he or she is required to act with undivided loyalty to the client. This includes disclosure of how the financial advisor is to be compensated and any corresponding conflicts of interest. If your advisor does sell products, it’s hard to know if your needs are deemed more important than his or her desire to earn a commission. A broker may be required to uphold a fiduciary standard depending on the services they are providing and designations they hold, so one option is to ask the advisor each time they make a recommendation. Attorneys, CPAs & Trust Officers are generally held to a Fiduciary Standard for all investment advice rendered.
In our view, Fee-Only Advisors held to a Fiduciary Standard of care represents the Gold standard in investment advice.