There has been a lot of talk in Washington DC recently as to whether all financial advisors should be held to a “fiduciary duty” in their dealings with investors. From my point of view, it is hard to see what could possibly be controversial about insisting that those who guide others in their financial affairs be held to the highest standard of duty and care.
Beyond industry critics fearing that higher duty will cost them money; some people think the entire matter is without consequence. They wonder aloud whether such duty is meaningless. “When interests diverge, doesn’t everyone do what is best for himself regardless of the effect on his clients?” This argument, while appealing to the cynic, misses the mark. The next time you are sitting in the doctor’s examining room, covered only by that flimsy paper gown, consider the importance of her duties to you. What would happen if the doctor did what was best for her rather than upholding your highest interests? You are totally in her hands. How profoundly do you depend on her to completely uphold the duty of care and loyalty that she owes you?
Your financial well-being runs a close second to your health. Even if they are not “life and death” matters, your investments, savings, and retirement may well spell the difference between comfort and misery in old age. They are certainly important enough to demand true professionalism from those who guide you. The rules currently in place, designed primarily to reign in the excesses of “financial salesmen,” are simply not sufficient.
Under existing regulations, most financial advisors must not sell or suggest investments that are “unsuitable” for their clients. Why isn’t that “suitability standard” adequate? Just for starters, consider costs and fees. Someone who can sell you anything “suitable” will surely choose that suitable solution which makes him the most money. Almost invariably, that choice is going to be a whole lot more expensive. After all, its cost must bear the weight of the seller’s commission or profit on top of everything else. While a fiduciary is supposed to look out for what is best for you; a salesman will seek what is best for him and also suitable for you. The difference will come out of your pocket.
How much is at stake when financial intermediaries put a bit more into their own coffers? Many years ago, a skeptical colleague challenged me to prove that the matter had financial significance. Her intuition was that but a few dollars were at stake. A mathematical proof being beyond me, I put one of my brightest young Wharton students on the case. He was instructed to find out how much it costs a client when a financial entity charges 2% more than necessary. Ever on the ball, the student requested instruction on a compounding rate (or, in plain English, the amount that the investment would grow on average each year). I asked him to use 7% per year as a conservative but realistic rate of growth. What his calculations revealed was startling. If a portfolio began with $100,000, an extra 2% of costs would be $2,000 after one year. It is the reduction in what is compounding at 7% that creates the shocker, though. After 30 years, that extra 2% would result in the portfolio being smaller by $431,916.57.
Viewed in this light, the opportunity to be guided by someone both highly skilled and committed to truly putting your interests first is worth a fortune. You are best off with a practitioner who acknowledges this high level of duty, understands it, and embraces it as part of professional practice. In turn, you should avoid anyone who is trying to make the very last dollar possible from their work with you.
How can you find a true fiduciary, though, as opposed to someone who is just mouthing that word? Start by looking at what real professionals do. Doctors and lawyers owe the highest level of duty to patients and clients. Accountants arguably do, too. Add clergy who spent long years studying in seminary to the list of those who understand that a significant portion of professional work involves care-giving and safeguarding. Ideally, you want someone who has undergone years of real professional training and socialization.
In reality, of course, it is most difficult to find a doctor or clergyman who is also deeply knowledgeable about financial markets and taxes. Thus, the second step is to look for practitoners who owe no duty to anyone else but you. The goal is to avoid any practitioner whose manager, company, or shareholders will outweigh their devotion to your best interests and needs. It will not go well for you if a sales quota holds priority over economic knowledge. Anyone working for a corporation may find it very difficult to subordinate a duty to those who sign their paychecks. You, however, can steer clear of guidance from anyone who puts the interests of others before yours.
The final step in finding a genuine fiduciary is the easiest. Simply ask. Anyone who offers financial services should be able to tell you that they have and honor an absolute fiduciary duty to you. They should find it easy to explain. And they should be willing to tell you fully and exactly how they make their money – every cent of it.
And now comes the most important part. They should be willing to put all that in writing. Ask them to send you a letter, on their official stationery, stating all of the above. That letter should say specifically that the signer acknowledges a fiduciary duty to you “as that term is traditionally understood in the law.”
If you receive such a letter, you have probably found yourself a true fiduciary to guide and advise you. If not, you have probably learned all you need to know about the person you were interviewing for the job.