Two little words, one short phrase, one enormous impact on your financial future.
Do you know how important this simple phrase is on your future? “Fiduciary duty”
This incredibly short phrase and easy to understand description could make or break your retirement. It’s the difference between a great advisor and one you should never do business with. It’s the difference in the portfolio that is truly designed to serve you long term versus the one that generates the most commissions for the advisor.
It may seem like I am overstating the importance of fiduciary duty, but it really is that critically important in your financial life.
What is Fiduciary Duty?
Here’s the short version of fiduciary duty: the professional you are working with is legally required to put your interests above their own.
Here’s a more detailed definition via BusinessDictionary.com:
A legal obligation of one party to act in the best interest of another. The obligated party is typically a fiduciary, that is, someone entrusted with the care of money or property. Also called fiduciary obligation.
That means if someone has a fiduciary duty to you they cannot act in their interest above your own.
Why is Fiduciary Duty Important in my Finances?
Don’t understand how important the above definition is?
Here are a few examples of the critical importance of fiduciary duty.
Fiduciary Duty with Investment Advisors
Let’s say you have been self-managing your investments over the years. You started small by setting aside a little bit of money each time you got paid and invested it into one of your accounts. You’ve done a good job and now have $200,000 set aside, but you have realized it is time to bring in a professional to help you protect that investment. You want to keep your capital safe while growing it over time, plus you need guidance on where to invest your income into your portfolio in the future.
The Bad Investor Advisor
You visit the first advisor and notice he is licking his chops as you describe your investments thus far as well as how much you plan to contribute in the future. Since he has no fiduciary duty to you, he crafts a portfolio that on the surface looks like a good option for you.
Below the surface is the reality that his investment choices for you include high expense ratios because those funds give a bonus if he has a lot of investments with them.
Further yet some of the funds include a 5% front loaded sales charge — meaning the company charges you $5 of every $100 you have invested, right off the top — that he gets a huge commission off of.
Even worse is he will call you every six to twelve months to encourage you to move your money around to various funds; this is called “churning” in the industry and results in further commissions for the advisor.
Nothing he is doing is technically illegal. It might be immoral, but since he has no obligation to put your interests above his there’s no reason to consider putting you first.
The Great Investment Advisor
When you visit the second advisor and tell him about the first, he just sadly shakes his head. He tells you — and shows you in writing — that he has a fiduciary duty to his clients. He legally puts himself below his clients in order to best serve their interests.
His portfolio plan for you is significantly different. To start he charges you by the hour at a fair rate. You know how much this is going to cost you on the front end; there are no hidden commissions that influence his decisions on your behalf.
His plan includes index funds with the lowest costs available. There are no marketing 12-1b charges. There are no front-loaded or back-loaded sales charge. He avoids investments that take a huge chunk of your money up front or on an annual basis. He also details out what you can do over the coming years to better protect yourself and your family as it comes to life insurance and trust funds. He avoids recommending expensive whole life insurance except in very specific wealth management situations and instead promotes term life insurance.
It is a comprehensive plan with no catches. You read the fine print just to make sure he isn’t trying to squeeze an extra buck out of you, but it turns out all he really wanted to do was to earn his hourly wage and put together a fair plan for you. No less, no more.
Fiduciary Duty with Company Directors
The same concept of fiduciary duty applies to businesses as well. Company directors and higher executives usually have a fiduciary duty to the business. Without it they could do things for their own personal benefit that do not put the company into a good position. Without a fiduciary duty the directors can personally profit from unethical moves by the company to the detriment of the entire organization.
How to Look for Fiduciary Duty
You might be thinking,
Okay, fiduciary duty sounds great. But how do I check for it with the investment and financial professionals I speak with?
It really is simple. You just ask to see it in writing.
For those professionals that do provide fiduciary duty to you, almost all of them will know what it means. They will be glad to show you documentation or sign any paperwork that puts you into a fiduciary duty relationship. They’ll also be glad to answer any questions about what it means in terms of how you work together.
What is sadly hilarious is when you speak to those professionals that do not know what it is, or worse yet, have been trained by their company as to what it is and how to sell around it because they know they don’t provide it. If anyone tries to tell you that you don’t really need fiduciary duty, thank them for their time and leave immediately. Their livelihood is based on earning commissions off of you rather than by providing a quality plan for your future.