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The vast majority of us save money and invest it so that when we are older we don’t have to work anymore. We would like to think that the financial advisor managing our money does so with our best interest in mind. But does this really happen?

The finance industry has a severely checkered history. We all have experienced, or know someone, who has been taken advantage of, manipulated, or simply sold a shoddy investment or insurance product. Even if the insurance or investment salesman has no malicious intent, which I would assume most do not, they can still push a high cost/low value product that generates a high commission for themselves but is not necessarily in your best interest. As a result, the financial services profession has a horrible reputation and a great amount of distrust from the public. This ought not be so! 

So, how can it change? One word…fiduciary.

Fiduciary is a legal term which, according to the Cornell Law School, is “the highest standard of care”. They go on to state that it involves primarily two duties:
  1. Duty of Care – the fiduciary must inform themselves of all material information before making a business decision. The fiduciary must assess all information with a critical eye and not simply accept information.
  2. Duty of Loyalty – fiduciaries are not allowed to use their position of trust to further their private interests. Specifically, they must protect the interests of the beneficiary, and they must refrain from anything that would cause injury or deprive them of profit which his skill might properly bring.
What does that mean in laymen’s terms?
 
A fiduciary is legally obligated to act in the best interest of their client and work with care, skill, and diligence. If a fiduciary is found to have violated those duties, then the fiduciary is legally liable.
 
In the USA starting in 2018, all investment advice pertaining to retirement accounts will be subject to a fiduciary duty. The old standard was measured by “Is the recommendation suitable?” vs “Have I diligently researched my recommendation, and is it in the best interest of the client?” Suitability can be met by merely having a good enough reason to make a recommendation. It is better than no reasonable basis, but suitability is not the highest standard of care.
 
Don’t we expect our financial advisor to act in our best interest? Of course we do!
 
I would diagnose this longstanding issue to two primary causes:
  1. Unethical Behavior Encouraged By Misaligned Financial Incentives – Billy Graham, a conservative religious leader, allegedly said, “Under the right circumstances there is no sin I would not commit.” He is right, and no matter how moral of a person you are, if you are in a high pressure, high commission, conflict of interest laden environment it will be very difficult to serve your client in their best interest. This is one reason why in the UK, the USA, and other developed countries the best practice is a fee-based arrangement where you pay by the hour of service or as a percent of the assets under management.
  2. A Very Low Hurdle to Work in an Advice-Giving Role – When someone treats your physical health you expect a medically trained professional who has studied and been trained, such as a nurse or doctor. Similarly, with your financial health, you want a competent and trained professional who takes their craft seriously and aspires to excellence. In finance, there are many ways to indicate your competency, whether through quality work experience, certifications (CFP, CFA, ChFP, etc.), education, and investment performance and risk management. There is a lot to understand in order to give competent advice regarding investments, insurance, tax, estate planning, and other financial areas of concern.
What Are the Drawbacks?
 
The main drawbacks that are put forth concerning the high hurdle of a fiduciary duty is the cost of service. If you want a highly trained professional attorney to assist you with your legal affairs you need to be willing to pay a premium ($250-$500+ per hour of service). Similarly, if you want a highly trained professional asset manager to provide competent advice you have to be willing to pay a premium. Many people will not like this idea, particularly if they do not have a sizeable amount of assets and are not used to paying for financial advice.
 
High-Level Takeaways
 
I tell my clients:
  • If I am ethical but incompetent, I can’t help you.
  • If I am competent but unethical, I will manipulate you.
  • But If I am ethical and competent, then I can advise you in your best interest.

Finding competent and ethical advice at a good price can make all the difference.Professionals need to get paid to stay in business but it is important that you are receiving commensurate value for your money.

Often times, investment products can have opaque and high fee structures that are not in the best interest of the client. Below is a graph depicting how a diversified portfolio would have performed with different levels of fees.
 

 


So, the next time someone tries to sell you financial advice, ask them, “Are you a fiduciary and what does that mean to you?”
 
Full Disclosure: Nothing in this article should ever be considered to be advice, research or an invitation to buy or sell any securities. The information is purely for educational purposes. Please consult your financial professional for investment guidance suited to your situation.

 

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