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While it may seem like a given, one cannot simply assume that a financial advisor always acts in the best interest of the client. This ambiguity lays the groundwork for what is known as fiduciary duty. While it is often associated with financial advisors, many professions can have a fiduciary duty. For example, attorneys, real estate agents and power of attorney representatives can also assume the role of fiduciary.
There are several types of fiduciary relationships. You should choose a financial advisor who abides by the fiduciary’s rules. In doing so, you’ll have the best chance of working with a financial advisor who will work in your best interest.
What does fiduciary duty mean?
A fiduciary duty is an ethical or legal relationship of trust between two or more parties. Generally, the fiduciary must act in the best interest of the other party. Depending on the type of fiduciary, they can be the result of a contract, which is often the case with attorneys, accountants and financial advisors. Other fiduciaries, such as executors, guardians and trustees may be required by law to accept a fiduciary duty.
Fiduciaries must act with the highest loyalty, honesty, and care to protect the beneficiary’s best interests. While many types of fiduciary relationships exist, this basic principle always applies.
5 types of fiduciary duty
Depending on the contract or law that requires fiduciary duty, there may be different types of obligations the fiduciary must assume:
1. Duty of care
The fiduciary must review all available information before making a decision. Then, they must act in a way consistent with how a reasonable person would act under the circumstances.
2. Duty of loyalty
The fiduciary must act in the client’s best interest and not in their own interests or the interests of their employer. They must also disclose any conflicts of interest, should they arise.
3. Duty of disclosure
The fiduciary must disclose all information that could impact the beneficiary or affect their ability to abide by their fiduciary responsibility.
4. Duty of confidentiality
The fiduciary must keep all information about the beneficiary private.
5. Duty of good faith
The fiduciary must take every measure to avoid breaking the law when fulfilling their fiduciary duties.
Fiduciary duties are important because they protect the interest of vulnerable clients. Without these responsibilities, the beneficiary may not be confident in the relationship.
Examples of a fiduciary relationship
Many types of work relationships may require a fiduciary duty. Here are some of the most common examples of fiduciary relationships:
A trustee and beneficiary of a trust
When creating a trust, a trustee names a beneficiary who will receive the assets in the trust at the appropriate time. However, as a fiduciary, the trustee must make decisions that are in the beneficiary’s best interest.
A guardian and ward
In this relationship, an adult (the guardian) becomes the legal guardian of a child (the ward). The guardian must ensure the child is well cared for and has everything they need in their daily life. For example, the child should have a safe, secure home and have regular checks from a doctor.
An attorney and client
An attorney must always act in the client’s best interest, including maintaining attorney/client privilege. The attorney should act fairly, be loyal, act with care and always prioritize the client’s interests.
A real estate agent and client
The real estate agent must act honestly, fairly and in the best interests of their client at all times. The agent must also keep all information confidential and disclose any potential conflicts of interest. They must also act in the client’s best interest, even if that decision would be to the agent’s disadvantage. They should also use their knowledge and skills to serve the client and avoid causing harm.
A financial advisor and client
A financial advisor should always prioritize the client’s interests. The most basic example of this is when making investment recommendations. The financial advisor should not lead the client toward investments that would earn a higher commission for them or their employer. Instead, they should make recommendations that lead to the best outcome for the client.
What is a breach of fiduciary duty?
A breach of fiduciary duty refers to a fiduciary’s failure to act in the client’s best interests. There are many ways that a fiduciary might breach their duty. For example, a fiduciary might:
- Make a decision that is not in their client’s best interests
- Use their position of trust to benefit themselves or their employer
- Fail to disclose important information to their client
If fiduciaries breach their duty, they may be liable for damages. The damages may be awarded to the client or to the government. In some cases, the fiduciary may be subject to criminal penalties.
How does fiduciary duty impact financial advisors
Fiduciary duty is a legal obligation to act in the best interests of the client. When a financial advisor has a fiduciary duty, they must put their client’s best interests first when making certain decisions, such as investment selections. For instance, they may not recommend investments that earn them a higher commission, or any to make more money for their employer. This scenario would represent a potential breach of fiduciary duty.
There are several other ways in which fiduciary duty impacts financial advisors. First, financial advisors must be transparent with their clients about their fees and commissions. Second, it requires them to provide detailed information about each investment’s risks and potential rewards. Third, it requires them to obtain informed consent from their clients before making any investment decisions. Failure to perform any or all of these responsibilities may represent a breach of fiduciary duty.
Choosing a fiduciary financial advisor
When choosing a financial advisor, it is important to choose a financial advisor who upholds the duties of a fiduciary. A financial advisor can help you with many key financial matters, such as managing investments, saving for a home, planning for retirement and tax planning. When making such critical decisions, it’s important to have someone who is on your side. That’s why finding the right financial advisor who will have your best interests in mind is so important.