Being a fiduciary means that you act in the best interests of others. In the case of a financial advisor, the National Association of Personal Financial Advisors (NAPFA) specifies that a fiduciary should always act in the best interests of their clients. Further, a fiduciary should be proactive in disclosing any conflicts of interest that might impact their clients.

What is a fiduciary? 

In general, a fiduciary is a person or organization that acts on behalf of another person or organization. Being a fiduciary involves putting their client’s interest ahead of their own. The definition of a fiduciary has been an evolving topic of discussion in the financial advisory space for several years now.

Attorneys, trust officers and financial advisors are among the professionals who may be required to act in a fiduciary capacity. NAPFA is a leading organization of fee-only financial advisors that requires its members to adhere to a fiduciary standard.

Fiduciary duty vs. suitability standard 

As financial advisory industry expert Michael Kitces said in a recent tweet, “Suitability means selling a suit that fits you. Fiduciary duty means that it has to look good on you, too.”

An investment or financial product that is suitable may not be appropriate for your unique situation. Suitability means that a financial product is suitable or may be a good fit for somebody in your general situation. This might be defined as someone who is the same age and marital status as you are, and whose income is roughly similar to yours.

An advisor adhering to their fiduciary duty to a client takes this a step further and does due diligence to help ensure that any investment vehicle or financial product is appropriate for their client’s unique financial situation. This takes into consideration their client’s goals, risk tolerance and other investments.

In choosing a financial advisor to handle your unique financial situation, you should decide if someone who gives generalized recommendations that may be appropriate for your broad situation is what you are looking for, or if you want an advisor who takes their duty of care seriously and tailors their financial advice to your unique needs. In other words, is a suit that just fits OK, or do you want one that looks good on you?

What is the difference between a fiduciary and a financial advisor?

Essentially, someone can be a financial advisor but not be a fiduciary. Investment advisors registered with the U.S. Securities and Exchange Commission (SEC), as well as with many states, have a fiduciary duty to their clients. They are obligated to put the interests of their clients first and to disclose any conflicts of interest that could influence the advice they give.

Many advisors working through broker-dealers may not be held to a fiduciary standard, but rather to the less stringent Regulation Best Interest standard, or Reg BI, as set forth by the SEC. The SEC says that this regulation imposes a standard of care on broker-dealers. These regulations do have some components of the fiduciary standard, including the duty to disclose potential conflicts of interest that could influence the advice they provide to clients.

Why it’s so important to work with a fiduciary financial advisor

While every investor should do what they feel is best for them, working with a financial advisor who is a fiduciary would be a wise decision. At a basic level, why would you want to work with an advisor who does not have an obligation to act in your best interests?

In choosing a financial advisor, you will want to ask a number of important questions.

  • “How are you compensated?” Ideally, you should seek out advisors who are fee-only. This means that all compensation they receive is paid by their clients, not by the providers of investment and financial products. Financial advisors are human, and they can be tempted to sell clients financial products that offer the highest compensation to them, whether or not these products are the best choices for their clients.
  • “Are you a fiduciary? If yes, will you put this in writing?” Any advisor who is truly a fiduciary advisor will gladly do this, often without you needing to ask. If an advisor claims to be a fiduciary but is hesitant to put that status in writing, that should be considered a huge red flag.
  • “Are there any conflicts of interest that you have that would preclude you from providing advice that is totally in my best interest?” A conflict of interest could be a requirement that the advisor’s firm may have as far as using certain types of required investment products for clients.

To be clear, determining if a financial advisor is a fiduciary is only a step in the process of choosing the best financial advisor for your situation. There are excellent advisors who are not fiduciaries that care deeply about their clients and do an outstanding job. There are also advisors who are fiduciaries who may lack the knowledge and experience in dealing with clients in your specific financial situation.

Nonetheless, determining whether an advisor you are considering is a fiduciary is an important step in the process of choosing a financial advisor. A good analogy to think about here: Would you knowingly use a doctor who only prescribes medications where they receive a kickback from the manufacturer regardless of what the actual best medication might be for your condition? Of course not. The same principle applies in choosing a financial advisor. All else being equal, you should generally lean towards using a financial advisor who is a fiduciary.