What protections are offered by a fiduciary?

(MoneyWatch) Welcome back to my second post that digs into what is means when a potential financial advisor says they will act as a fiduciary on your behalf. My previous post compared the fiduciary standard with the suitability rule for financial advisors and brokers, and you'll want to read that post for background to better understand this post. As you'll see, you'll most likely want to work with an advisor who will act as a fiduciary, but you'll also want to ask more questions before determining if a potential advisor is best for you.

While the fiduciary standard is more rigorous than the suitability standard, it does not protect you from the potential incompetence of the advisor. So you'll need to make sure they have the training and experience necessary to make recommendations that are appropriate for you.

As I've written previously, financial planning becomes much more complex when you're approaching or in retirement. That's because you'll need to devise strategies for using your retirement savings to generate reliable retirement income and for determining the best ages to claim your Social Security benefits, as well as learn how to protect yourself from the potentially ruinous expenses for long-term care. These goals require different skills than investing and accumulating assets during your working years, and you're best-served by advisors who have received specialized training in these areas.

More subtly, the fiduciary standard won't protect you from biases that the advisor may have. For example, some advisors are more comfortable with investing solutions to generating retirement income due to their training and background, while others may be more comfortable with insurance solutions (i.e. annuities) that will generate the retirement income you need. You'll be best-served by learning the basics of generating retirement income on your own so you can have an intelligent conversation with any financial advisor. One word of advice: Steer clear of any advisor who automatically guides you toward or away from any specific approach before learning of your goals and circumstances.

The fiduciary standard also doesn't protect you from paying too much for advisory services. A plan advisor who is acting as a fiduciary can still charge you a high fee, although truly excessive fees could violate the fiduciary standard. You'll want to ask potential advisors how they're paid and how much their services might cost each year.

One common method of paying for financial advice is a percent of assets under management. An annual charge of one percent is common -- and acceptable -- for individual planners, while 0.5 percent is common for advice provided through 401(k) plans.

Charging a percent of assets under management will test advisors who act as fiduciaries for people approaching retirement. Will they recommend products that may be best for your circumstances such as low-cost immediate income annuities? Such an annuity would remove assets from management and hence reduce your advisor's fees. In fact, financial advisors have a name for this situation: "annuicide."

In theory, a financial advisor would put the client's interests before their own, and would make recommendations that they think would truly work best for their clients. But theory is harder to implement in the real world when the financial incentives for the advisor aren't aligned with the interests of the client. One way to avoid this potential bias is to choose an advisor who charges by the hour or by the project; they'll be less likely to be conflicted by this dilemma.

The fiduciary standard also won't protect you against stock market declines. You and your advisor might decide that your risk tolerance can accommodate stock investments. If you and your advisor believe such investments are appropriate given your age and financial circumstances, and then the market drops and takes your savings with it, the fiduciary standard won't prevent you from losing money. In this case, you can't look to your financial advisor to bail you out.

Experts in logic have an apt phrase to address the situation of choosing an appropriate advisor: necessary but not sufficient. Think of the fiduciary standard as a minimum -- or "necessary" -- requirement for a potential financial advisor. But you'll need to ask additional questions about their experience, training and fees to sufficiently determine if a financial advisor is best for your circumstances. Don't let yourself be sold by marketing statements that your advisor will act as your fiduciary.

Given the importance of your task -- establishing your financial security for the rest of your life -- it will be time well spent.

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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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