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What Is a Fiduciary?

By Motley Fool Staff – Jul 15, 2016 at 5:25PM

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Is your financial advisor acting in your best interest? It you're working with a fiduciary, you're probably in better hands.

Many of us don't have the insight and expertise to manage our own money, and so we turn to professionals for help in making key financial decisions. But not all financial advisors are created equal, and if you get stuck with someone who isn't as ethical and trustworthy as you'd hope, you run the risk of losing money. Thankfully, many financial advisors operate under what's known as the fiduciary standard. A fiduciary is a person who maintains a relationship of trust with one or more parties. A fiduciary typically manages money or other assets on behalf of another person. Though not all financial professionals are fiduciaries, new laws were recently established to compel more advisors to adhere to the fiduciary standard.


The fiduciary standard

The fiduciary standard was established as part of the Investment Advisers Act of 1940. It states that an advisor must always act in the best interests of his or her clients and place clients' best interests before his or her own. It also means that an advisor must make sure to provide financial advice that is sound, accurate, and free from conflicts of interest. Furthermore, fiduciaries are required to disclose any potential conflicts of interest to their clients, and must strive to transact on behalf of clients in a manner that's as efficient and low-cost as possible.

Fiduciary versus suitability standard

Not all financial professionals are bound by the fiduciary standard. Many broker-dealers, insurance agents, and advisors are simply required to operate under what's known as the suitability standard. The suitability standard dictates that a financial professional can only recommend investments that are suitable for his or her clients. However, unlike the fiduciary standard, the suitability standard does not compel professionals to put their clients' needs and interests ahead of their own.

Let's say an advisor is held to the fiduciary standard and comes across two comparable investment opportunities for a client. If one option has a slightly higher commission, the advisor cannot recommend that investment, because paying a larger fee is not in the client's best interest. Under the suitability standard, however, the advisor in question would be allowed to recommend the investment with the higher commission as long as it's suitable for the client -- meaning it could potentially yield results that are in line with the client's goals without exposing the client to undue risk.

Expanding the reach of the fiduciary standard

In April 2016, the Department of Labor announced that a growing number of financial professionals will soon be required to adhere to the fiduciary standard. This ruling specifically applies to professionals who offer financial advice for retirement accounts such as IRAs and 401(k) plans. Advisors who fall into this category will be required to act in their clients' best interests with regard to investing and managing not just retirement plan assets, but distributions as well. The goal of compelling more professionals to act as fiduciaries is to help protect otherwise unsuspecting clients from losing countless dollars to high fees and commissions. However, the updated rules apply only to those who manage retirement accounts, which means that clients seeking financial advice for non-retirement assets must continue to be cautious about whom they trust. 

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