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A fiduciary is an individual who acts in the best interests of others. When it comes to financial advisors, the National Association of Personal Financial Advisors (NAPFA) mandates that a fiduciary must always prioritize the well-being of their clients. Additionally, a fiduciary should be transparent in disclosing any potential conflicts of interest that could impact their clients.
Understanding the Role of a Fiduciary
Essentially, a fiduciary is a person or entity that represents another party and is obligated to prioritize the interests of that party above their own. The duties of a fiduciary extend beyond those of a typical financial advisor due to the heightened level of care involved. Therefore, not all financial advisors operate as fiduciaries, despite some advisors attempting to blur this distinction.
Professionals such as attorneys, trust officers, and financial advisors may be required to act as fiduciaries. NAPFA, an esteemed organization of fee-only financial advisors, mandates that its members uphold a fiduciary standard. Similarly, financial advisors holding the certified financial planner (CFP) designation are also held to fiduciary responsibilities.
Fiduciary Duty vs. Suitability Standard
Financial advisors are typically held to either a fiduciary standard or a suitability standard when providing guidance to clients. The disparities between these standards underscore the varying levels of care that advisors must exhibit towards their clients.
As industry expert Michael Kitces has aptly stated, “Suitability means selling a suit that fits you. Fiduciary duty means that it has to look good on you, too.”
While suitability implies that a financial product may suit someone in a similar situation to yours, a fiduciary goes further by conducting due diligence to ensure that the product aligns with the client’s unique financial circumstances, including goals, risk tolerance, and existing investments. When selecting a financial advisor, it is crucial to determine whether you prefer generalized recommendations or tailored advice that prioritizes your specific needs.
Distinguishing Between a Fiduciary and a Financial Advisor
It is important to recognize that an individual can be a financial advisor without operating as a fiduciary, highlighting the significance of understanding these distinctions. Here are key differentiators:
Registered investment advisors under the U.S. Securities and Exchange Commission (SEC) and many states are held to a fiduciary duty towards their clients, requiring them to prioritize client interests and disclose any potential conflicts of interest. In contrast, advisors associated with broker-dealers may adhere to the less strict Regulation Best Interest standard established by the SEC.
Instances of breaching fiduciary duty can lead to legal repercussions, including lawsuits and potential compensatory or punitive damages. Collaborating with a fiduciary financial advisor is recommended due to their obligation to act in your best interests at all times.