In June, the U.S. Department of Labor began transitioning toward full implementation of the Fiduciary Rule, which requires advisers who provide retirement advice to place their clients’ interests first. As I wrote in February, the Fiduciary Rule has sparked controversy ever since it was first introduced by President Obama, and efforts continue to try to prevent the Rule from taking effect in its current form.
Even though placing a client’s interests first seems like common sense, our complicated financial system doesn’t require it of some advisers. For example, in addition to those covered by the Fiduciary Rule, Registered Investment Advisers (RIAs), must also meet a fiduciary standard set forth by the Investment Advisers Act of 1940. Broker/dealers, who often also use the title of “adviser,” are exempt from the standard as long as their advice is incidental to the conduct of their business and they don’t receive special compensation for advice. Confused yet? It gets even better!
How an adviser gets paid can also be an indicator of how well his or her interests align with yours. A number of you have asked me what the difference is between an adviser who is “fee-only,” versus one who is “fee-based,” or “commission-based.” Let’s follow the money and look for potential conflicts of interest:
Clients who pay commissions based on their investments may not even realize they’re paying fees at all. That’s because their adviser (often an insurance broker or a stock broker) receives a commission based on the sale of a product. The commission is deducted from the client’s investment portfolio, so the client never sees an invoice. The amount of any commissions and fees may be buried in lengthy, lawyerly-sounding documents, and may be difficult for the average client to find or understand. In addition, these commission-based advisers may receive compensation from financial product providers as an incentive to sell a particular investment product to more clients. In short, a commission-based adviser may recommend products that pay a larger commission or incentive, instead of a product aligned with your best interests.
Fee-based advisers may use a fee-only structure for advice while earning commissions on the sale of products. Some fee-based advisers are RIAs, meaning they must place the client’s interests first when providing advice. However, these advisors can “switch hats” in a relationship to sell products and receive commissions. When doing so, they are no longer fiduciaries. Instead, they must follow a “suitability” obligation, in which they are required to recommend only products that are suitable for the client. Again, if the adviser has two suitable products, but one offers a higher commission, he or she may be tempted to recommend the investment that favors the adviser, and/or the firm.
Fee-only advisers receive compensation from just one source: the client. They can be paid by the hour or by a percentage of assets under management (AUM). These advisors do not sell financial products and are obligated, as RIAs, to place the client’s interests first. Advisers in this category will disclose their fees and any potential conflicts of interest with their clients.
How do you know what you’re getting when you work with an adviser? Ask for a summary of all fees and commissions in writing. That should include front-end loads, trailing commissions, and any other fees – including those paid to the adviser by a third party. If you are working with an adviser who recommends a product, ask him or her to explain – in writing – the basis for the recommendation and whether it is in your best interest. Another option is to ask the adviser to sign a fiduciary pledge before you engage in an advisory relationship.
AMDG Financial is a fee-only RIA, and we take our fiduciary responsibilities seriously. Each year, we submit to a voluntary assessment by the Centre for Fiduciary Excellence (CEFEX) to determine whether our business practices meet fiduciary criteria. As part of the assessment, an independent analyst reviews all of our written records, conducts interviews, and examines evidence to show that AMDG Financial looks out for our clients’ best interests in all of our business processes. We were the first firm in Michigan and one of the first in the world to participate in this exercise because of our commitment to be the best for our clients.
If you have further questions about choosing a fiduciary adviser, I invite you schedule an appointment to get to know us better. We look forward to talking with you!