What Does Fiduciary Responsibility Mean?

With the rise of the fee-only movement in recent years and the ever-increasing awareness of how financial advisors are compensated for the advice they provide, the term “fiduciary” has become more important and prevalent than ever before. Chances are you’ve likely heard this term before, but you may not know what it truly means, what responsibilities are implied, or why understanding these responsibilities is so important when working with a financial advisor. The truth is, there tends to be a lot of confusion around the term and when an advisor or investment professional is presumed to hold its status. In this article, I’ll seek to clear up some of this confusion around the term and answer the frequently-asked question: what does fiduciary responsibility mean?

Fiduciary Definition

According to Investopedia, “a fiduciary is a person who acts on behalf of another person, or persons to manage assets in good faith and trust.” In other words, a fiduciary is a person or organization that is both legally and ethically bound to act in the best interests’ of another person or group of people. In the advisory, this would apply to any advisor outside of a broker-dealer that has discretion in investment accounts they manage for you.

In these situations, the advisor is bound by the law to provide advice and decisions they believe to be in their client’s best interests, not for the sake of profit (e.g. commissions) or personal benefit from the assets managed. By legal definition, this is the highest standard of care an individual or organization can be bound by.

Breaking Down Specific Fiduciary Responsibilities

In the investment advisor world, there are two main responsibilities, or duties, that a fiduciary is subject to; the duty of loyalty and the duty of due care. The duty of loyalty simply means the advisor may not operate in any capacity against their client. All actions taken must be for the benefit of their client whether it is beneficial for the advisor or not.

The duty of due care is similar in meaning but pertains more specifically to avoiding harm to the client while taking all circumstances into account. In other words, the adviser is expected to provide a degree of judgment, care, prudence, determination, and activity for their client with any and all influencing circumstances in mind.

For example, if a client is planning to purchase a new home in the coming months, it would be expected that the advisor would not recommend investing those funds in an aggressive stock portfolio or as that could potentially harm the client’s ability to accomplish this goal. In all, these responsibilities ensure the advisor always acts solely in the best interests of their client. If not, the client possesses the right to sue the adviser in a court of law.

Why It’s Important

It’s easy to assume that any financial advisor would automatically be a fiduciary. This is simply not the case, however, as advisors are currently regulated by two separate standards of conduct depending on their compensation structure and registration status.

Investment advisers registered with the SEC or a state securities regulator, for example, are considered fiduciaries. They typically maintain discretion in the investment accounts they manage and usually compensated by asset management fees.

Stockbrokers, broker-dealer representatives, or insurance agents, on the other hand, are subject to the “suitability” standard of conduct. They are regulated by either FINRA or state insurance regulators and can derive their compensation from commissions on transactions.

The issue with those subjected to the suitability standard is they’re not required by law to act in their clients’ best interests and their commission compensation structure can put them in direct conflict with those interests. If an insurance agent, for example, can make a larger commission selling one product over another to a client, they’re more incentivized to sell the larger commission-paying product regardless of the benefit or lack thereof to the client.

How it Affects Me

If you know the financial advisor you’re working with is a fiduciary, you have a much higher degree of certainty that they are in fact acting in your best interests plus plenty of recourse via the legal system if they don’t.

Unfortunately, many people are unaware of their advisor’s fiduciary status and, more times than not, their adviser is bound solely by suitability standards. In order to get the best advice possible and ensure your adviser always acts in your best interest, you should always look for a fiduciary advisor. Fee-only investment advisors or fee-for-service financial planners are never compensated by commissions and are therefore always bound to act in your best interests.

If you’d like to work solely with a fiduciary, fee-only advisor or simply would like to review your current financial situation, schedule a free consultation with us today.  

Chad Rixse grew up in Anchorage, Alaska, but has lived in the Seattle area since 2007. He majored in Spanish at the University of Washington where he honed his fluency in the language and discovered his passion for travel and connecting with other cultures. He’s a self-professed golf addict who can never seem to get his fill despite still struggling to break 100.