Working with a financial advisor has its benefits. These professionals can help you analyze your finances, define your goals and create a plan to reach them — whether it’s buying a house, paying for an education or retiring comfortably. Even better, you’re likely to feel less stressed about your finances when you seek financial advice from a professional.
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When you start looking for a financial advisor, you’ll discover they have an array of titles and professional designations. You’ll also notice a number of advisors who say they are fiduciaries, and you may wonder what makes them different from other types of advisors who do not use the term.
Fiduciary and financial advisor are related terms, but they are not synonymous. Some fiduciaries are financial advisors, but the term also includes individuals who do not work in finance. It describes a relationship between someone who has the authority to make decisions for someone else. A financial advisor can be anyone who offers financial advice to others — and this person may or may not be a fiduciary. Here’s a closer look at how they compare.
What Is a Financial Advisor?
Financial advisor is a broad term that describes professionals who assist clients with decisions about investments, money management, financial goals and more. They may concentrate in an area like retirement planning or estate management. Some sell finance-related products like insurance, and others advise clients about taxes. A financial advisor who manages investments like stocks and bonds must have a license and register with the Securities and Exchange Commission.
The following titles can fall under the umbrella of financial advisor:
What Is a Fiduciary?
A fiduciary is a person who agrees to oversee property that belongs to someone else, and they do so on the other person’s behalf. For example, you may have a power of attorney that gives you the authority to access a parent’s bank account to pay bills when they are incapacitated. In that situation, you use the money to pay your parent’s bills and not your own. You also agree to keep accurate records of how you spend the money and make sure everything you do is in your parent’s best interest.
In finance, the term fiduciary refers to a financial advisor who puts the needs and interests of their clients first while managing their assets — even if it cuts into the advisor’s earnings. They agree to follow a code of ethics, which includes sharing with the client current or possible conflicts of interest and explaining how they make money. For example, an advisor who earns a commission for each insurance policy they sell must disclose this information to the client if they recommend the product because it’s in the client’s best interest. Failing to do so is a violation of the law and their code of ethics.
What’s the Difference Between a Fiduciary and a Financial Advisor?
The primary difference between a fiduciary and a financial advisor is that a fiduciary is legally obligated to act in a client’s best interest. This may seem like it should be the standard for all types of financial advisors, but in a legal sense, it is not.
Traditional financial advisors, such as brokers at a financial services firm, are only legally required to make suitable recommendations for clients, based on their investment objectives and risk profiles. This means that financial advisors can choose from a number of suitable investments to recommend to a client, rather than the absolute best option. This can tempt some financial advisors to steer clients to investments that, while suitable for clients, pay them higher commissions or fees.
Fiduciaries, on the other hand, are held to the higher standard of picking only what is in a client’s best interest, regardless of how much — or how little — they may earn from it.
This is one of the many reasons why many fiduciaries are fee-based, rather than commission-based. By working for an annual fee, fiduciaries are in a better position to align their own interests with those of their clients. When a financial professional is not incentivized to pick an investment because it pays a higher commission, it makes it easier to serve a client’s best interests. This isn’t to say that ethical financial advisors don’t practice the same diligence in serving their clients. But it does mean that they are not legally obligated to do so.
Fiduciaries also typically directly manage client investments rather than simply offering advice. Whereas a financial advisor may merely make recommendations and build financial plans for clients, fiduciaries often make decisions as to which investments clients should own and then execute those trades on the behalf of clients, without getting specific approval for each individual trade.
How Do You Know If a Financial Advisor Is a Fiduciary?
There’s a dizzying array of titles in the financial services industry, and it’s not always easy to know if your financial professional is a fiduciary or not. Many financial advisors may actually be fiduciaries, but not all will be. Some investment professionals may label themselves “financial consultants” or “financial planners,” and those unofficial titles won’t necessarily reveal whether or not a professional is a fiduciary. Even loftier-sounding titles like “senior vice president of investments” may not be a good enough clue to determine whether or not someone is a fiduciary.
For these reasons, the most direct way to find out if your financial advisor is a fiduciary is to ask them. Here are some questions to consider, according to a fact sheet from the U.S. Department of Labor Employee Benefits Security Administration:
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Do you consider yourself a fiduciary? If the answer is no, find out why. If the answer is yes, ask them to give you a written document stating they are a fiduciary and promising to let you know about potential conflicts of interest when they provide recommendations.
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How are you compensated? It’s helpful to know whether your advisor gets paid by a fee charged to you or a commission received from the products they sell to you. If the advisor receives a commission, you can ask for a list of the products and the percentage they get.
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Are you a licensed or registered investment advisor? You can check with the licensing agency to verify the advisor’s membership. Also, consider asking about disciplinary action or claims against the advisor from previous clients.
Another way to identify a fiduciary is through the titles the advisor has. An advisor with any of the following certifications belongs to an organization that expects its members to act in the client’s best interest:
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Accredited Investment Fiduciary (AIF)
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Certified Financial Planner (CFP)
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Chartered Alternative Investment Analyst (CAIA)
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Chartered Financial Analyst (CFA)
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Certified Financial Fiduciary (CFF)
Accreditations like these not only guarantee that an advisor is acting in your best interest but are also a solid indication that the financial professional has experience and advanced knowledge in the industry. Even without their fiduciary responsibility, accredited individuals are generally seen as having dedication to their profession and the willingness to abide by ethical codes.
Should I Use a Fiduciary or Financial Advisor?
If you prefer the comfort of knowing the person helping you make financial decisions is working in your best interest, look for an advisor who is a fiduciary. When you find one, get an agreement in writing so you know exactly what to expect. A fiduciary standard is a standard of care, and it’s essential that you understand how often your advisor will be working in that capacity.
However, this doesn’t mean that non-fiduciary financial advisors are poor at their jobs or that they still don’t take their clients’ best interests to heart — it just means they have no legal responsibility to do so. The bottom line is that if you work with an advisor who you know you can trust and who provides you with excellent advice, you may not need a fiduciary. But all other things being equal — particularly if you are looking to work with a new financial professional — it’s generally better to pick a fiduciary than a non-fiduciary financial advisor.
John Csiszar contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: Fiduciary vs. Financial Advisor: What’s the Difference?
