Choosing Advisors and Fiduciary Duty

Who works for whom: registration, duty and the title nobody owns

“Financial advisor” describes a job, not a legal standard, and the people who use it fall into a few groups. A **registered investment adviser** — registered with the SEC or a state — is paid to give advice and owes a **fiduciary duty** under the Investment Advisers Act of 1940: a duty of care and a duty of loyalty that cover the whole relationship, which means putting the client’s interest first, disclosing conflicts, and either eliminating them or making them clear enough to consent to. A **broker-dealer** representative is paid mainly to execute transactions and since June 2020 has been bound by **Regulation Best Interest**: a recommendation must be in the retail customer’s best interest at the time it is made, conflicts must be disclosed and managed, and the broker may not put its own interest ahead of yours — but there is no ongoing duty to monitor the account once the recommendation is made. The lines blur in practice. Many large firms are **dual registrants**, whose representatives can act as an adviser for one account and as a broker for another, so the standard that applies depends on the capacity they are acting in for that recommendation. Regulation Best Interest presumes that a firm which is only a broker-dealer cannot call itself an “adviser” or “advisor”, but the title on a dual registrant’s card tells you nothing about which hat is being worn. Certified Financial Planner professionals add a third layer: the CFP Board requires them to act as fiduciaries whenever they give financial advice. Insurance agents selling annuities work under state rules of their own. Every firm that serves retail investors must hand you a short **Form CRS** — a customer relationship summary — that states the services, the fees, the conflicts, the standard of conduct and whether there is disciplinary history. It is the one document written to be compared side by side, and the right place to start, followed by the regulators’ databases. Read the Form CRS before the first meeting, not after the first recommendation. • Registered investment adviser: fiduciary duty of care and loyalty, for the whole relationship. • Broker-dealer: Regulation Best Interest at the time of each recommendation; no duty to monitor afterwards. • Dual registrants wear both hats — ask which one applies to each account. • CFP professionals: fiduciary when giving financial advice. Form CRS: the comparison document every firm must provide. The standards, side by side — Investment adviser: Fiduciary — care and loyalty, for the whole relationship · Broker-dealer: Best interest at the time of a recommendation (Reg BI) ← · Dual registrant: Depends on the capacity for each account — ask · CFP professional: Fiduciary whenever giving financial advice

How advice is paid for — and the conflict every model carries

There is no conflict-free way to pay for advice, only conflicts you can see and manage. **Commissions** reward transactions and product choice, so the conflict is toward more trading and toward products that pay more. A **percentage of assets** — 1% a year is common — rewards gathering and keeping assets, so the conflict is against anything that moves money out of the account: paying down a mortgage, buying an annuity, spending in retirement. **Flat or retainer fees** and **hourly** advice-only planning remove most product and asset conflicts, at the cost of paying for advice whether or not it is used. “Fee-only” means the adviser is paid only by the client; “fee-based” usually means fees plus commissions, which is a different arrangement with a similar-sounding name. The model that looks cheapest is often the most expensive over time, because a percentage fee is charged on a growing balance and compounds against you. The calculator in this lesson prices it. On a $500,000 portfolio earning 6% a year before costs, a 1% advisory fee leaves $1,693,177 after twenty-five years; a $3,000 flat fee leaves $1,981,342; index funds costing 0.05% with no adviser leave $2,120,772. The percentage fee looks like $5,000 in the first year and costs about $428,000 over the period against doing it yourself — and $288,000 more than the flat fee, possibly for the same planning work. None of that makes the percentage model wrong. It may be the right price for someone who wants the assets fully managed and would not manage them well alone. It makes it a price that should be stated in dollars, compared with what it buys, and renegotiated as the balance grows — a fee that was sensible on $200,000 can be expensive on $2 million for the same work. • Commission: conflict toward trading and higher-paying products. • Percentage of assets: conflict against moving money out of the account; compounds with the balance. • Flat, retainer or hourly: fewest product conflicts; you pay for the advice whether or not you use it. • “Fee-only” = paid only by you; “fee-based” = fees plus commissions. $500,000 for 25 years at 6% before costs (this lesson’s calculator) — 1% of assets a year: $1,693,177 · $3,000 flat fee a year: $1,981,342 · Index funds at 0.05%, no adviser: $2,120,772 · Cost of the 1% fee against doing it yourself: About $428,000 ←

What good advice is worth — and how to hire it safely

Good advice can be worth more than it costs, and the industry’s own estimates say where the value comes from. Vanguard’s “Advisor’s Alpha” research puts the potential at about three percentage points of net return, with behavioural coaching — keeping a client invested through a crash, or out of a mania — alone worth up to about one and a half. Vanguard is careful to say the value is not earned every year: it is lumpy, concentrated in the moments of panic or euphoria when an unadvised investor is most likely to abandon the plan. Treat the number as an argument for what to buy rather than a promise, because it comes from a firm that sells advice and varies enormously from client to client. So buy the parts that are worth buying: a plan that fits the household, the right accounts and tax structure, a written policy (PF17), and someone who will stop you selling at the bottom. Pay for portfolio management only if you will not do it yourself, and compare robo-advisers and planning-only services, which deliver much of the mechanical work for far less. Then interview with five questions, and ask for the answers in writing: Are you a fiduciary at all times and for all my accounts? How are you paid, in dollars, by me and by anyone else? What conflicts do you have, and how are they handled? What does your Form CRS say, and what do BrokerCheck and the SEC’s adviser database show? And who holds my money? The last question is the safety check that matters most. A legitimate adviser directs the investments while an **independent custodian** — a large brokerage or bank — holds the assets in your name and sends you statements directly. Madoff’s clients received statements from Madoff, whose own firm held the money, and that arrangement is what allowed the fraud to run for years. If the person who chooses the investments also holds them and produces the only statements you see, do not hire them, however good the returns look. • Industry estimates: about 3% of net return from good advice, mostly behavioural — intermittent, not annual. • Buy planning, structure and behavioural coaching; pay for management only if you would not do it. • Five questions: fiduciary always? paid how, in dollars? conflicts? Form CRS and records? who holds the money? • Insist on an independent custodian that sends you statements directly. Five interview questions, and the answer you want — Fiduciary at all times, for all accounts?: Yes, in writing · How are you paid, in dollars?: A clear figure — no surprises from third parties · What conflicts do you have?: Named, with how each is handled · Records?: A clean Form CRS, BrokerCheck and adviser database · Who holds my money?: An independent custodian that reports to you directly ← An adviser who chooses the investments, holds them and writes the only statements you receive has removed the one check that catches fraud.

Do you need a person at all? Robo-advisers, target-date funds and doing it yourself

Much of what an adviser does is mechanical, and the mechanical part is now cheap. A **target-date fund** chooses an allocation for a retirement year, rebalances it and shifts it toward bonds over time, inside a single holding, often for around a tenth of a percent a year in index-based versions. A **robo-adviser** builds and rebalances a diversified portfolio from a questionnaire, typically for about a quarter of a percent a year on top of fund costs, and many add automated tax-loss harvesting. For a household with simple finances and the discipline to leave the portfolio alone, one of these plus the plan from this subject covers most of the ground. A person earns the fee where the problems are not mechanical: a business to sell, equity compensation, a complicated tax position, an inheritance, a divorce, a parent to support, or a retirement income plan with several moving parts. And a person earns it where the household knows its own behaviour is the risk — the client who sold in March 2020 and wants someone to call them next time. That is the part of advice the industry’s own research values most, and it is the part no algorithm delivers. Hybrids sit between the two: a robo-style portfolio with access to human planners, or an hourly planner who writes the plan and leaves the implementation to you. The decision is easier when it is made in dollars. Price each option per year on your actual balance, list the specific problems you need solved, and buy the cheapest arrangement that solves them — remembering that the cheapest option you will abandon in a crash is not cheap. • Target-date fund: allocation, rebalancing and glide path in one holding, often around 0.1% a year for index versions. • Robo-adviser: automated portfolio and rebalancing, typically about 0.25% a year plus fund costs. • A person is worth it for complex problems — and for behavioural coaching. • Hybrids: robo plus planners, or hourly planning with do-it-yourself implementation. The options, by what they cost and what they solve — Do it yourself with index funds: Cheapest; needs time and discipline · Target-date fund: Low cost; one holding; the glide path is the provider’s · Robo-adviser: About 0.25% a year; automated rebalancing and tax harvesting ← · Human adviser or planner: Highest cost; complex problems and behavioural coaching

Sources

• Regulation Best Interest and Form CRSU.S. Securities and Exchange Commission, Release No. 34-86031 (2019)
• The fiduciary duty of investment advisersSEC, Commission Interpretation Regarding Standard of Conduct for Investment Advisers (2019)
• What advice is worth, on an industry estimateVanguard, “Putting a value on your value: Quantifying Advisor’s Alpha”
• Checking an adviser or a brokerSEC Investment Adviser Public Disclosure; FINRA BrokerCheck
• The fiduciary standard for certified plannersCFP Board, Code of Ethics and Standards of Conduct