| Featured Author: Austin Hagaman |
“Fiduciary Duty” Is a Confusing Subject for Many Investors
Many investors are confused about the obligations Brokers and Registered Investment Advisors have with their clients. When asked if investors understand the differences between Brokers and Registered Investment Advisors an overwhelming 97% of respondents said they do not, according to a survey by the financial news and analysis website AdvisorOne.com.(1). Bloomberg also reports that, “Three out of four U.S. investors mistakenly think that financial advisers at brokerage firms are required to put clients’ interests first”. (2). This confusion is a problem and could indicate that many investors, under the recommendations of an advisor, are making financial decisions that are not in their best interest.
Understanding the Differences between Brokers & Registered Investment Advisors (RIAs)
The Suitability Loophole
If you are one of the many individuals who think their financial professional is legally obligated to act in a fiduciary manner, when they are not, .
” target=”_blank”>your portfolio and your wallet could be suffering from what I call the “suitability loophole”.
The suitability loophole is quite simple to explain. Unlike Registered Investment Advisors, Brokers are only legally obligated to give advice that is “suitable” for clients. This means a Broker is legally allowed to recommend a mutual fund that is only suitable for your needs but pays a high commission to him/her, even if a similar and cheaper mutual fund is available.
Tamar Frankel, a law professor at Boston University, explains, “[The Broker uses his] expertise to give you something that you can use, that’s suitable for you. But suitability doesn’t mean cheapest. It may be suitable, but you can go next door and get it at half price.” (3).
Registered Investment Advisors, on the other hand,are held to a fiduciary duty to act in their clients’ best interest; and therefore, must go above suitability standards and consider investment options that are priced the best for their clients.
Commission vs. Fee Compensation
Another major difference between Brokers and Registered Investment Advisors is their structure of compensation. Brokers typically earn commissions on the securities they trade while Registered Investment Advisors are typically fee-only or fee-based, charging a percentage of assets managed.
Commission based compensation can create additional conflicts of interest that fee-only and fee-based structures do not have. For example, Burton Malkiel, author of A Random Walk Down Wall Street states,“If you’re a securities broker, you’re going to want to sell the things where you make the most money, where your commission is greatest. For me, that’s the opposite of how it should be. Investment advice should have the fiduciary duty that the customer comes first.” (3).
Every investor should understand whether their financial advisor has a fiduciary duty to clients before utilizing their services. If you are not sure whether your financial advisor has a fiduciary duty to you, you can:
- Search for the advisor’s Form ADV on the SEC’s Investment Advisor Public Disclosure Website.
- Ask your advisor directly if they have a fiduciary duty to clients and if they are a Registered Investment Advisor (RIA) as defined by the Investment Adviser Act of 1940: If your advisor does not immediately answer this question in a confident and concise manner, then, chances are, your advisor is not obligated to act in your best interests.
(1). AdvisorOne.com. Key Findings of fi360-AdvisorOne Fiduciary Survey of Advisors. http://www.advisorone.com/2012/04/26/key-findings-of-fi360-advisorone-fiduciary-survey?t=fixed-income&utm_source=dailywire42612&utm_medium=enewsletter&utm_campaign=dailywire .
(2). Bloomberg.com. `Clueless’ U.S. Investors Believe Brokers Have Fiduciary Duty, Survey Says. http://www.bloomberg.com/news/2010-09-15/-clueless-u-s-investors-believe-brokers-have-fiduciary-duty-survey-says.html
(3). Observer.com. Broken Brokerages: Finance Luminaries Join Fight Over Uniform Fiduciary Standard. http://observer.com/2012/08/broken-brokerages-finance-luminaries-join-fight-over-uniform-fiduciary-standard/?show=all .
PWM is a fee-only Registered Investment Advisor (RIA) and a client fiduciary. The above article is for information purposes only and should not be construed as an advertisement for PWM Advisory Group, LLC (PWM). Due to various factors, including changing market conditions and/or applicable laws, the presented material(s) may no longer be reflective of current opinions or positions. The thoughts and opinions expressed in the presented material(s) relate only to the author and are not necessarily reflective of PWM’s views. Moreover, you should not assume that any discussion or information contained in the presented material(s) serves as the receipt of, or as a substitute for, personalized investment advice from PWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Photo Credit: B Tal – Flickr
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