Fiduciary duty is one of the most important terms you will ever learn in regards to your retirement. It isn’t an investing or retirement term; it is a legal term. This term can change the course of your retirement and influences the decisions you make for retirement greatly. It’s that important.
What is Fiduciary Duty?
In legal terms, fiduciary duty is the obligation of one party to act in the best interest of another party. The obligated party is known as the fiduciary, since they have the duty to the other party. When it comes to money or investments, a fiduciary would take care of your investments or offer you advice that served your interest over their own.
Why is Fiduciary Duty Important?
When you are speaking with a financial advisor about your money, investments, and retirement, you have to know whose interest they have in mind. An advisor might have a relationship with a specific mutual fund company where they earn a commission by getting you to invest money into those funds. Advisors should be compensated for their services, but what if the funds they steer you toward have high costs and aren’t the best option for your situation? That’s why fiduciary duty is so important. It’s the difference between being steered toward the best investment for your situation or an average (or worse, mediocre) investment that benefits your advisor more than it does you.
Ask About Fiduciary Duty
The easiest way to find out if the person you are receiving investment advice from legally has your best interest in mind is to simply ask them:
“Do you have a fiduciary duty to me?”
It is a simple yes or no answer. If they stumble over their words, say they need to check with headquarters, or say they will ask their Compliance Department… the answer is no. If they say yes, then you know they legally have to keep your interests in mind above their own. That’s where you want to be.
Two Types of Investment Advisors
What you will quickly find is there are two types of advisors: commissioned advisors and fee-only advisors.
Commissioned advisors get paid a sales commission by putting you into different investments. Sometimes they are commissioned by not only getting you to invest, but then getting you to switch your investments around (known as “churn”). Every time you buy or sell you are most likely generating a commission for the advisor. As you might imagine, the advisor simply can’t have your best interests in mind with this scenario. If I’m your advisor and I can earn my firm a 5% commission for getting you into Investment A or a 0% or 1% commission for getting you into Investment B, I’m going to do all I can to get you into Investment A regardless of whether or not it is in your best interest. My job and income rely on generating commission from you.
The other type of financial advisor is a fee-only advisor. The name tells you how they get paid: they charge a flat or hourly fee to put together a plan for you. Since you both parties know up front how much money the advisor is going to make off of providing advice to you, they can offer unbiased advice. They aren’t encouraged to put you into poor or costly investments to benefit themselves. They’ve already been paid by you. It levels the playing field. You can find a fee-only advisor at the National Association of Personal Financial Advisors. As you might expect, the fee-only advisor is more likely to hold fiduciary duty for you. Just remember to ask. Never assume just because you’re paying a flat fee that the advisor has your best interests at heart.