Advisor and fiduciary: Duties and selection

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If you're in the market for a financial advisor, you may hear potential candidates tell you, "I will act as a fiduciary on your behalf." While that sounds reassuring, do you know what this designation actually means?

This topic is becoming increasingly important now that more 401(k) plans are offering financial advice through their 401(k) plans. According to a recent survey by human resources consulting firm AonHewitt, 39 percent of plans currently offer professional advice for 401(k) participants while they're accumulating their nest egg, and 19 percent provide advice during the pay-down phase in retirement. Many of these professional advisors will act as the fiduciary for plan participants, and this is a prominent feature in their marketing strategy.

If you participate or have participated in a 401(k) plan or are looking to hire a financial advisor, you should be aware of a fiduciary's duties and capabilities. Toward that end, let's take a look at the two possible standards that financial advisors can adhere to:

  • The "fiduciary standard" means that the advisor must act in the best interests of the client and put the client's interests ahead of their own. A fiduciary would be prohibited from making recommendations that produce higher commissions for themselves in the role of financial advisor or their investment firm.

  • The "suitability rule" means that the advisor must reasonably believe that a recommendation is suitable given the client's circumstances, needs and objectives. In this case, the advisor is not referred to as a fiduciary and does not need to put their client's interests before their own or the interests of their financial institution.

Clearly, the fiduciary standard is more rigorous and appears to better protect people than the suitability rule does. But let's review a few examples of each standard to better understand the differences.

Suppose you tell an advisor that under no circumstances do you want the principal value of your investments to decline. In this instance, an advisor would violate both the fiduciary and suitability standards if they then recommended equity investments, which can depreciate in value. But an advisor would be adhering to both standards if he or she recommended most forms of guaranteed investments such as certificates of deposits, bank accounts, and/or U.S. government obligations that are held to maturity, where principal is expected to hold its value.

In this same example, an advisor working under the suitability guideline could also recommend investments of the financial institution they work for, even if other investments might offer a better rate of return or lower costs. The recommended investment just needs to be suitable to the client's goals and circumstances, but it doesn't necessarily need to be the best investment, with the lowest cost or highest expected rate of return.

However, an advisor would theoretically violate the fiduciary standard if he or she recommended investments from their own institution that were clearly more costly or were reasonably expected to produce lower returns compared with similar investments. Under the fiduciary guidelines, not only should an investment be suitable to your circumstances, but the advisor must also act with the client's best interests in mind.The fiduciary standard goes farther in protecting investors than the suitable standard.

It may seem clear that the fiduciary standard is better than the suitability standard. But that is not sufficient to screen candidates for advisor/fiduciary role. You'll have to determine whether a potential financial advisor is best equipped to play that role and can help you develop a plan for a secure retirement. My next post discusses criteria to keep in mind when seeking a financial advisor.



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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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