Editor’s note: According to Investopedia, the “Fiduciary Rule,” scheduled to be phased in April 10, 2017 – Jan. 1, 2018, may be delayed for up to 180 days.
The one question every investor should ask
Financial advisors will have a new regulation to deal with starting in April, and it’s the biggest change the financial advice industry has seen since the great recession. It’s called the “Fiduciary Rule,” and it will have a significant impact on how financial advice is delivered. It is important that investors understand what this change is, and why it’s important.
Introduced by the previous administration, the fiduciary rule will require financial advisors to put the client’s needs before their own. Yes, you read that right. Until the rule officially goes into effect, your financial advisor may not have your best interest in mind.
As the law currently stands, there are two standards that advisors are held to, the suitability standard and the fiduciary standard. The suitability standard gives advisers the most wiggle room. It simply requires that recommendations must fit clients’ investing objectives, time horizon and experience. You can satisfy the suitability standard by recommending the least suitable of the options, as long as it falls within the general suitability test of that client. The suitability standard invites conflicts of interest pertaining to compensation, which can vary greatly from one product to another.
It also doesn’t require advisors to disclose conflicts of interest. So what that means is often the products that are being recommended are best for the broker, and have higher costs for the investor. It is estimated that non-fiduciary advice costs Americans approximately $17 billion each year.
The other standard of care, the fiduciary standard, tasks advisors with putting their clients’ best interest ahead of their own. For instance, faced with two identical products but with different fees, an adviser under the fiduciary standard would be compelled to recommend the lower cost option to the client, even if it meant fewer dollars in his or her own pocket.
Unfortunately many investors can’t distinguish among advisors who is a fiduciary, and who isn’t. Studies have shown that individual investors don’t know who is a fiduciary or what a fiduciary actually is. So here are a few questions to help you sort through
How often do you monitor my investments?
Investors don’t ask this question often, because most investors assume the advisor keeps a close eye on their portfolio. A common reason for using an advisor is insufficient time to self-manage. Hopefully, you are not paying an annual fee for an advisor to put your money into passive index funds and not monitor their performance. If your advisor is not analyzing your portfolio at least quarterly, you may want to discuss the services offered for the annual fee you pay.
What is your investment philosophy?
Paying careful attention to the advisor’s answer can offer insight into the business model. Although there is no one-size-fits-all approach, all advisors should have a disciplined and repeatable investment approach. Markets fluctuate, and strategies that may have been in favor last year might perform terribly the next year. An advisor who chases performance and lacks an underlying process often generates poor returns. If they are pitching a new “hot” fund every time you meet, they may not have your best interest in mind.
How much am I really paying?
Disclosure requirements have improved since the financial crisis, but “hidden” fees remain. Often, when selecting a financial advisor, clients base their decision on the advertised fee. In some cases, there may be no fee referenced at all. Is the advisor working for free? If the fee seems too low, that may also be concerning. The advisor may be receiving ongoing service fees from the investment they are recommending. This undisclosed compensation is a big conflict of interest. Beware, as these fees can become a significant cost over time, compared to the explicit fees of a fiduciary advisor. A typical fee-based advisor has a tiered structure based on account size that is disclosed to a client up front. Selecting an advisor with a reasonable fee is important, but what you get for that fee is equally relevant. If one advisor is a fiduciary and the other is only held to the suitability standard, the difference in fees may not paint the full picture. Investing in an advisor who has your best interests at heart could pay handsomely over time.
When it comes to choosing a financial advisor, take nothing for granted. Know what you are paying for, and what services you are entitled to. Remember, a misguided broker focused on his or her next commission could cause you financial ruin.
Mike Desepoli, AIF, is the vice president of Heritage Financial Advisory Group