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Michael Passante, CFP

MPassante@FocusedWealthMgmt.com

www.focusedwealthmgmt.com

 

 

 

 

In the investment world, there are two distinct types of parties who provide advice about investments and financial planning to both individual and institutional clients. These are known throughout the industry as investment advisors, who are required to act as fiduciaries, and brokers who act as an agent for someone else. Clients may believe that the advice they receive from each party is similar, but there is a key difference in how they operate that may not be completely understood by the investing public. The two entities operate under a vastly diverse business structure and are held to completely different standards. This has significant implications on the clients who hire them to provide both financial planning and investment advice. Below we provide an illustration of each party so you can better understand whether your financial professional is held to fiduciary standards.

Investment brokers are defined as individuals who act as intermediaries, bringing together the buyers and sellers of investment products. They help individuals make important financial decisions under the suitability standard. Under the suitability standard, a broker can meet with their client to determine what a suitable investment may be at that point in time. What is deemed suitable by the broker depends on the client’s goals and risk tolerance. The broker generally goes through the details of a prospectus which contains comprehensive legalese outlining that the fund they recommended is operated by the bank or institution that employs them. The prospectus also provides an outline of the compensation structure the broker will receive. This generally includes an up-front commission the client pays to buy whatever product or products the advisor recommends. Once the transaction has been executed and the client leaves the broker’s office, they have little further legal obligation to monitor the client’s investment or overall financial situation on an ongoing basis. At the end of the day the broker acts as an agent for the company they are employed by and are not always required to keep the clients best interests in mind.

The picture is drastically different under the fiduciary standard. According to the Securities and Exchange Commission, investment advisors provide a broad array of services. These services include assisting individuals and institutions in making financial decisions pertaining to retirement planning, and developing investment strategies to manage client assets and portfolios. They may manage individual portfolios which are divided up to address several investment objectives. Investment advisors generally charge fees for their services which can either be on an hourly basis or a percentage of the assets they manage for their clients. Registered investment advisors are bound to a fiduciary duty of care and are bound by the Investment Advisors Act of 1940. The fiduciary standard requires advisors to put the client’s interests above their own at all times.
The investment advisor also has a “duty to care” which means they must continually monitor not only a client’s investments, but their changing financial situation. Investments must be altered if a client’s goals or risk tolerance changes. For example, a client may have recently retired which requires a restructuring of a portfolio geared toward stability of principal and income production. Perhaps there was a tragedy in the family or a client’s risk tolerance shifted after going through a painful bear market. Under the suitability standard the broker is not required to follow up on these changes and the result can be a portfolio that falls out of line with an individual’s goals or needs. For fiduciaries, the advisor has a continuous legal obligation to be proactive.

Recently, President Barack Obama spoke about financial advisors and the financial services industry. In this speech, President Obama endorsed fiduciary standards and is pushing to require all financial advisors to put the client’s needs before their own. The sad truth is, that unless your financial professional is specifically held to fiduciary standards, they are not required to hold your best interests in mind. As the law currently stands, brokers, insurance salespersons, and advisors only operating under the “suitability standard” are merely required to ensure an investment is suitable for a client at the time of investment.
When it comes to selecting a financial advisor, some important questions ask are “How often do you monitor my investments?” Investors often don’t ask this question because they simply assume the advisor will keep a close eye on their portfolio. Your advisor should be analyzing your portfolio at least quarterly, if not on an ongoing basis.

Another question to consider is “What is your investment philosophy?” Pay careful attention to this answer as this can often offer some great insight into both the business model and the overall knowledge your advisor possesses about markets. All advisors should follow some form of disciplined approach. The investment environment is constantly changing, but someone with a tried and true approach may provide better long term results than the advisor pitching the next hot fad.

A third essential question to ask your advisor is “How much am I really paying?” Don’t be afraid to not only ask about the advisory fees, but the fees associated with the specific products being recommended. There are often undisclosed internal costs of investments that can add up and erode portfolio performance over time. These should be disclosed.

At the end of the day, when it comes to selecting an investment advisor, you can ask all the questions you want, but the most important question is “Do you have my best interests in mind?” Regardless of which advisor you choose, ask if they act and are held to a fiduciary standard. A good advisor will have a grounded and disciplined philosophy. They will also customize a plan to your lifestyle and review the plan on a consistent periodic basis. If you aren’t receiving this type of comprehensive service, it’s time to rethink your current plan and whether it will satisfy your long term goals.

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