Why blindly relying on the Fiduciary Standard can be a mistake

When it comes to choosing a financial advisor, many clients look for someone who adheres to the Fiduciary Standard. This standard requires financial advisors to act in their clients' best interests, putting their clients' financial well-being ahead of their own. However, blindly relying on the fiduciary standard can be a mistake and below are a few reasons why.

Conflicts of interest still exist

A fiduciary advisor may still have an incentive to recommend products or services that benefit them more than their clients, and they may do so while remaining compliant with the Fiduciary Standard. "How's that possible?" you may ask. Let's examine a very common scenario:

1. Advisor John begins working with clients Jim and Brenda. John discusses doing financial planning for them, as well as managing their investments of $500K. John charges Jim and Brenda 1.25% annually as an advisory fee on their assets, which equates to $6,250 in annual fees. Jim and Brenda assume that John will be adding value to their portfolio by managing it, but unbeknownst to them, John turns that responsibility over to his broker-dealer. The broker-dealer uses a generic mutual fund (or ETF) model that simulates a standard 70/30 stock to bond portfolio. This type of portfolio can be easily replicated many places for no advisory fee at all, and while advisor John is well aware of that fact, he doesn't bring it up to Jim or Brenda.

   • From a financial planning standpoint, John spends 8 full hours reviewing data and preparing some financial planning recommendations. He spends two hours meeting with them to review the plan for a total of 10 hours. Therefore, John's hourly equivalent first year earnings rate is over $600 an hour, well in excess of industry average hourly rates.

   • In year two, John conducts two reviews (semi-annual), and spends an hour preparing in advance for each (total of four hours). Most of the heavy lifting was done in year one, and the maintenance of a financial plan is much easier. John's hourly equivalent rate in year two is over $1,500 an hour, over triple industry average hourly rates (using the same starting asset balance).

In this scenario, advisor John was aware that charging an asset fee would equal far more income than doing planning work at reasonable hourly rates (even if he used higher end average rates). Given that neither advisor John, nor his broker dealer, were doing anything special with Jim and Brenda's investments, it would have been in the clients' best interest to simply charge them hourly for financial planning. Additionally, it would have been in the clients' best interest to suggest they obtain the appropriate 70/30 portfolio at a firm where there would be no fee. However, despite these glaring conflicts, this scenario is incredibly common among advisors that promote themselves to be Fiduciaries, and as things stand it is not considered a violation of the Fiduciary Duty.

From a Fiduciary standpoint, advisors should be actively involved and aiming to provide unique value to a client's portfolio if they charge asset management fees (with a few exceptions discussed in this post). Otherwise, it's simply taking advantage of the fact that the money earned is much higher, and much more consistent, than charging clients hourly or even fixed-rate fees.

"Fiduciary" has become a marketing term

As with many buzz phrases in personal finance, the word "fiduciary" has become overused as a marketing term. I hear and see it in advisor advertising all of the time, and it suggests to people that the particular advisor is risk-free versus some advisor that isn't a fiduciary. I’m guilty of that as well because I share that I operate under the fiduciary standard here on this site. I do so because it has become such an important word in the industry and for prospective clients. However, I also try to provide balance to the subject by sharing these important limitations.

While the fiduciary standard can be a useful guideline for choosing a financial advisor, it is not a guarantee of good advice or conflict-free recommendations as discussed. Clients should be aware of the limitations of the Fiduciary Standard and do their own research when choosing a financial advisor.

Subjectivity

While the above scenario is a highly common example of Fiduciaries not living up to the word, there is a much less egregious reason to not blindly trust the Fiduciary Standard: Subjectivity. What one advisor truly believes is best for a client could be wildly different from what another advisor truly believes is best. Both could be on a stage debating it out and and listeners would also have varying opinions as to which advisor is correct. There have been plenty of attempts to standardize what financial advice should be, but the nuance of real life makes that incredibly difficult. Just know that in investing and financial planning, there is rarely only one "right" answer.