Alignment refers to the extent to which the advisor’s interests or motives agree with the client’s. There are two alignment paradigms:
Investment advisors who work for Registered Investment Advisory firms, companies registered with the federal Securities and Exchange Commission (SEC), typically have a fiduciary duty to their clients—the highest form of allegiance. The same applies to advisors working for smaller, state-registered investment advisory firms.
Some private-sector (non-government) credentials also impose a fiduciary duty on advisors. For example, members of the National Association of Personal Financial Advisors (NAPFA) take a fiduciary oath. Those who qualify as Certified Financial Planners™ (CFP®) through the Certified Financial Planner Board of Standards also accept a fiduciary duty when engaged in financial planning.
In contrast, securities brokers don’t have a fiduciary duty. They are bound only by the suitability requirement. Their governing body is the Financial Industry Regulatory Authority, Inc. (FINRA), a non-government regulator for securities companies engaged with retail customers in the United States. Like securities brokers, insurance brokers and agents are compensated with commissions, which raises serious conflict of interest issues and concerns regarding lack of fiduciary duty.
A non-fiduciary can legally give you advice that is best for him, but not best for you. For example, it may allow him to earn high fees at your expense.
Advisors who are directly employed by an insurance company (captive agents), or by a firm that provides brokerage services, or one that offers its own proprietary investment products, may be conflicted. This is because such advisors most likely have specific financial incentives to sell their employers’ products, resulting in less choice for you, both in terms of product quality and fees. We’ll revisit this in the section on Advisor Fees.
The alignment picture can get quite confusing because legally an advisor may be held to a fiduciary standard when giving you retirement investment advice for your 401(k) or 403(b) account, and later in that same conversation she may be held only to a suitability standard when recommending insurance purchases.
Following the subprime crisis there was a push to expand fiduciary duty, leading to formulation of what became known as the Department of Labor's Fiduciary Rule. The Fiduciary Rule was hamstrung by industry lobbying and never got off the ground. In 2019 the SEC enacted Regulation Best Interest (Reg BI). Reg BI purports to impose a higher standard of care on brokers, but critics feel it falls short of requiring them to meet a true fiduciary standard and only makes the landscape more confusing for consumers. A Forbes article explains Rule BI along with the concerns expressed by some market participants.
No sane consumer would design a financial services industry that is littered with such confusion and potential conflicts of interest. But that’s the system we must live with today. It’s the result of intense lobbying over decades by industry insiders who have in aggregate extracted billions of dollars in compensation—from our nest eggs! Since the government has not seen fit to provide us with full protection, it falls to us to look out for our own interests. That is, in a nutshell, the motivation for writing this book.
If you want an advisor who is not conflicted, owes you the greatest allegiance, and must provide you with the best advice for your situation and circumstances, your logical choice is to utilize the services of an independent advisor acting as a fiduciary.
Independent advisors are not directly employed by providers of financial products, such as insurance or asset management companies. They are free to offer you a broad range of products and services sourced from many providers, and to help you make good selections among the choices.
If you only need help executing trades, a (non-fiduciary) broker may be sufficient. In such cases, consider using a discount brokerage firm that doesn’t make trade recommendations and will execute trades at lower fees. Similarly, if you only need an insurance product, find an independent insurance broker who offers a selection of products from a variety of insurers.