Should Financial Advisors Be Fiduciaries?

A reader writes, asking:

“Do you think that a financial advisor should be a fiduciary? I’ve seen that discussed elsewhere, but never on your blog.”

Well, that depends on exactly what you mean.

If you’re in the market for a financial advisor, and you’re wondering whether you should use one who is a fiduciary (i.e., one who has a legal duty to put his/her client’s interests first) or one who is not, my answer would be, “Yes, use an advisory who has a fiduciary duty to you.”

This is a bit of an oversimplification, but in general:

• Registered investment advisers (RIAs) and representatives thereof do owe a fiduciary duty to clients.
• Insurance agents and stockbrokers do not owe a fiduciary duty to clients.

In the case of insurance agents and stockbrokers, they earn their pay by selling you specific products, which tends to result in biased advice. (This is not to say that RIAs are without their biases. Even fee-only RIAs have conflicts of interest, but I think they are at least somewhat less significant than the conflicts of interest faced by brokers and insurance agents.)

On the other hand, if you’re asking whether I think all financial advisors should be fiduciaries — a question which has been the subject of a great deal of debate within the industry over the last several years — I don’t have any strong opinions. I think it’s probably a good idea. (After all, why shouldn’t somebody who calls himself/herself a financial advisor be legally required to put clients’ interests first?) But, frankly, I’m not optimistic that such a change would have a large positive impact on the industry.

As it is, there are countless RIAs (who do have a fiduciary duty) who do all sorts of things that, in my opinion, clearly show they’re putting their own interests ahead of their clients’ interests. Yet, regulators don’t seem to have any problem with it.

For instance, many RIAs charge in excess of 1% per year to do nothing but passive portfolio management. At the same time, at Vanguard, you can get similar portfolio management, plus a basic financial plan, plus access to a CFP for 0.3% per year. The idea that the advisor charging more than three times as much for a lower level of service is somehow putting his/her clients’ interest first is laughable, given that there is such an obviously-better option for the investor. And yet, industry regulators have no problem with this — it is apparently not considered a breach of fiduciary duty.

And that’s not even remotely the worst of it. There are RIAs who charge high annual fees while also using expensive actively managed funds. There are RIAs who charge high annual fees while rapidly trading concentrated portfolios of individual stocks — or engaging in any number of other poorly-researched investment strategies. And, in the overwhelming majority of cases, such activities are not considered to be a breach of fiduciary duty.

In other words, if you’re going to use an advisor, yes, you should probably use one who has a fiduciary duty to you. But the sole fact that an advisor has a fiduciary duty does not ensure that he/she will always do what’s best for clients.