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In the past, we’ve written extensively about the differences between a financial advisor and a fiduciary or registered investment advisor (RIA). We’ve also calculated how much a commission-based brokerage can eat up your profits.
But are fiduciaries that much better?
After all, Bernie Madoff was, technically, registered as a fiduciary.
It’s true that fiduciary financial advisors are held to a higher standard. Registered investment advisors are legally required to put your interests first—but legality and reality can differ widely.
A financial advisor, fiduciary or not, is a human at the end of the day. You can have meticulous, law-abiding fiduciaries. Then there are scammers or, at best, incompetent advisors.
So, how can you tell the difference?
It’s not easy.
That’s why today, we wanted to talk a bit about how to vet your potential fiduciary advisor.
Before we get into questions you can ask your potential advisor, we need to define a few things.
First off, what is a fiduciary financial advisor.
To summarize: A fiduciary advisor or financial planner is a finance professional with the sole responsibility of ensuring their clients get objective advice.
These advisors are normally registered under the Investment Advisors Act of 1940 or similar state-specific regulations. All fiduciaries report to the SEC, and should expect regular audits. Unlike commission-based advisors, RIAs get paid through a flat fee—usually 1%. Normally this fee covers all, or most of their services, such as providing investment advice, estate planning, or managing your 401(k).
That said, the industry has its loopholes. For example, many brokers are now registering as dual-licensed advisors.
Under this license, an advisor is both a commissions-based broker and a fee-only fiduciary.
The problem: How will you know when they are selling you a financial product, or they are genuinely recommending an investment that matches your financial plan?
You don’t.
That isn’t to say a dual-licensed advisor may not care about your financial success. After all, if they charge you a fee, then they earn more when you earn more. But the ambiguity makes it much easier for unscrupulous individuals to mint money.
There are many questions you may want to ask and should ask any financial advisor. But these seven questions are essential for determining whether or not an RIA appears reliable and trustworthy.
An honest fiduciary will be open about what act they are registered under. RIAs can be registered under the Investment Advisors Act of 1940 or a similar state law. For example, Encompass Advisors is registered under the North Carolina Investment Advisers Act.
Brokers will be registered under the Securities Act of 1933.
This question is especially helpful if an advisor tells you they are a fiduciary, but this term is not written anywhere.
It can be helpful to understand how your advisor thinks. Do they use hard data and expect losses? Or do they only seem interested in gains and new financial products.
Investing is all about risk, and losses are expected. In fact, a sound investor will try to minimize risk but never guarantee a “no-risk” investment. They simply don’t exist.
A custodian is a platform that hosts your account—common examples being Vanguard, Fidelity, and Schwaab. Bernie Madoff did not use a third-party custodian, and it’s a red flag if an advisor does not go through a third-party.
Working with an external brokerage provides another layer of security for the client since the money will not be directly with the advisor. In addition, the custodian logs all transactions, making it more difficult to hide fraud.
Another important question to ask is whether or not the advisor is directly related to the custodian. This is particularly important if you don’t recognize the organization.
For example, let’s say Advisor A works with a small custodian, Slightly Shady Financial Services. But this custodian is owned by Advisor A’s spouse.
Now, a fraudster will likely not say this directly. You may, however, be able to get a feel for the advisor’s transparency.
An honest advisor should be able to supply you with client references, as well as information from others he’s worked with. This can include tax professionals, other advisors, or a law firm.
That said, pay attention if clients rave about “fantastic returns.” All portfolios go through rough periods, and if clients are mysteriously getting non-stop gains, it could be a red flag.
The market can fluctuate wildly, and the last thing you want is an advisor who fails to answer your questions during rough periods. Or, worse, tells you everything is “okay” without explaining why—particularly if you are earning during a down market.
Fiduciary advisors are generally paid a percentage fee for all Assets Under Management (AUM). This fee is usually, but not always, 1%. Payments may take place all at once or be spread out. The billing structure differs from one advisor to another.
It’s important to note that brokers or dual-licensed advisors also make money when you buy and sell a security. If the advisor’s clients discuss excess buying and selling stock, this could signify this “churning” scam.
In any case, if the advisor is not clear about their billing practices, it’s a clear sign to walk away.
Questioning your potential advisor is important, but it’s often safer to do additional research on your own. Scammers like Bernie Madoff are incredible at portraying credibility and confidence. Many fraudsters are likable, someone you would want to have dinner with.
The good news is that financial advisors, particularly fiduciaries, have a documentation trail. And it’s easier to review their information than before.
FINRA’s BrokerCheck allows you to review brokers, fiduciaries, and firms for disclosures, violations, and legal settlements. All RIAs are required to register and report annually to the SEC, so you can also learn more about client disputes, legal action, and your advisor’s history there.
You may also be able to find information on your state’s Securities website, NASAA, or the CFP Board.
It is possible to report a fiduciary advisor if you feel you have been taken advantage of. Normally you would file a complaint with FINRA and the SEC.
However, remember that losing money is not enough for a complaint. No advisor can guarantee profits, no matter how trustworthy or upstanding they are.
A successful claim highlights that the advisor caused the losses through a breach of duty, namely negligence or fraud. You may want to speak with a lawyer or another advisor before filing, to ensure that your experience is aligned with what FINRA the SEC considers misconduct.
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