Broker Vs. Fiduciary: How Are They Different?

Posted by Dan Ebinger & Jake Sadler on July 18, 2022

Broker Vs. Fiduciary: How Are They Different?

The advice you receive from a financial advisor can put you on track to realize your dreams, whether they involve building a business, passing down wealth to future generations, or something else entirely. However, in some cases, if the financial advice you receive isn’t in your best interest, it can lead you away from your goals.

To protect and grow your hard-earned wealth, it’s crucial to work with a fiduciary financial advisor who can help you craft a solid plan for your future. In this post, we’ll explain the difference between a broker and fiduciary and highlight the key steps to take when hiring a broker vs. fiduciary.

Are you ready to talk to a fiduciary financial advisor about your investment strategy and portfolio? Schedule a call with Bay Point Wealth today.

Broker Vs. Fiduciary: A Brief History And One Key Difference

Technology and consumer behavior have driven high demand for fiduciary financial advisors in recent years. However, the legal lexicon has used the term “fiduciary” for centuries. In the world of finance and investments, it refers to an advisor who is legally obligated to act in their clients’ best interest. This duty of care is known as the fiduciary standard, which we’ll dig into shortly.

Until the last 20 years or so, most Americans received financial advice from investment brokers who managed accounts with stocks, bonds, and mutual funds—and weren’t legally held to the fiduciary standard. As the internet began to make information more accessible, and as Ponzi schemes began to appear in the news, people started to become more discerning about their finances and who they trusted with their money. The popularity of financial planning as a profession also increased drastically around this time, spurring consumers to seek out fiduciary financial advisors.

Fast-forward to today, and the historical evolution of the term “fiduciary” has left us with competing definitions that exist across industries. Professionals in other fields—real estate for example—use the term, but in ways that are specific to their field. This can debase consumers’ understanding of what being a fiduciary financial advisor truly entails, particularly if consumers see sales-driven fiduciaries doing very little to address possible conflicts of interest.

While fiduciary status is becoming increasingly important in our hyperconnected digital world, it doesn’t need to be a confusing concept. In simple terms, the comparison between a broker vs. fiduciary boils down to one question: Who is the advisor working for? A broker is working for their firm; a fiduciary is working for you, the client.

Fiduciary Vs. Suitability Standards

Fiduciary financial advisors and investment brokers are both in the business of providing advice. However, the key difference between a broker and fiduciary is the standard that governs each individual. The legal fiduciary standard set by the Securities and Exchange Commission (SEC) requires financial advisors to place their clients’ interests above their own when providing financial advice.

In contrast, the suitability standard set by the Financial Industry Regulatory Authority governs investment brokers. The suitability standard requires brokers to refrain from selling financial products that they don’t consider to be suitable for their clients—but it doesn’t go as far as mandating that they put their clients’ interests above their own. Unlike the fiduciary standard, the suitability standard doesn’t obligate brokers to disclose conflicts of interest, either.

As a client, it’s important to feel confident that your financial advisor is acting in your best interest and providing you with advice that’s right for your personal situation. This is why the fiduciary standard offers you greater protection. While many investment brokers are upstanding professionals, the suitability standard leaves room for you to question their motivations in a particular situation.

Who Should Hire A Broker (Vs. Fiduciary)

Despite the risks associated with the suitability standard, brokers are appropriate for some clients. It’s helpful to think about their role this way: Ultimately, a broker’s job is to facilitate transactions. By definition, they act as a middle person to link a buyer and seller. In other words, they’re brokering a deal. (The word is right under our nose!) However, the term “broker” has become shorthand for someone who can give you investment advice. This is a fundamental (and, often enough, consequential) misconception.

Pro Tip: When considering whether to hire a broker vs. a fiduciary, ask yourself if what you’re seeking is advice, or simply someone to broker the sale (to you) of financial products through their company in accordance with your directives. You can properly classify the role of a broker when you draw that distinction.

Over the course of your life, there are various transactions you might need to engage in that require a broker’s services. For example, if you’re buying or selling a house, you’ll need a real estate agent to broker the deal. In addition, if you’re buying life insurance, you’ll need an insurance broker to sell it to you. In most states, insurance brokers are the only people who can legally offer life insurance, so you need them to facilitate that transaction.

When it comes to the world of finance, if you have a high level of knowledge about the stock market and want more control over your portfolio, your best option may be to work with an investment broker. Just be sure you understand the difference between working with a broker to facilitate investment transactions vs. getting investment advice.

In contrast to an investment broker’s role to facilitate the transactions you ask them to carry out, a fiduciary financial advisor will work on your behalf and make decisions they believe are right for you based on their expertise. So, if you’re not savvy about investing (or if you want to delegate the responsibility), a financial advisor held to a fiduciary standard of care is likely a better fit for you.

In addition, if you’re looking for overall financial planning guidance that includes proactive tax planning expertise, it is important to consider a fiduciary financial advisor who has a duty of care and an obligation to advise only on matters in which they are sufficiently knowledgeable. They’ll seek to understand your financial goals and build a long-term relationship with you, to help you achieve your objectives in a way that’s right for you and your family.

Broker vs. Fiduciary: 3 Key Steps For Deciding

We’ve now covered the difference between a broker and fiduciary, and a few situations in which it makes sense to hire a broker vs. fiduciary. Now, let’s talk about several key factors to consider when hiring one or the other. If you’re looking for a financial advisor and you ask them the following questions, you’ll quickly narrow down the field.

1. Find out if they are a fiduciary.

This is the most important question to ask a financial professional right off the bat. Working with a fiduciary can give you invaluable peace of mind that your money is in good hands. When researching investment managers, a good place to start is by looking for a Registered Investment Advisor with the SEC. For more broad financial planning, seeking out a financial advisor with a Certified Financial Planner (CFP®) designation is a wise move. These advisors are licensed professionals held to fiduciary standards.

The CFP® code of ethics and practice standards has recently been updated by the Board to establish a working definition of the term “fiduciary,” which is decidedly stronger than the standard Department of Labor definition. All CFP®s must abide by this definition, which references a duty of loyalty, duty of care, and duty to follow client instructions. This is critical, because you want an advisor who, in addition to being credentialed, educated, and competent, is ethically and legally mandated to adhere to these principles.

Financial firms should make sure their advisors are meaningfully credentialed, and the CFP® designation is one of the best in the business—especially for setting advisors apart by virtue of their fiduciary duties. A CFP® will be in violation of their fiduciary duty if they’re advising you on matters they’re not well versed in, because they’re required to operate within their circle of competence. Financial advisors are in many respects generalists, but a CFP®’s role—rather than acting as an expert in all areas—is in many ways to curate the appropriate resources to get you the answers you need, with your best interests in mind.

2. Ask if there are any instances in which they don’t operate under the fiduciary standard.

Oftentimes, a financial professional can wear the hats of both an advisor and a broker, depending on the situation. For example, they may work for a broker-dealer who also has a registered investment side to the business. The advisor may wear their fiduciary hat when managing your investments but put on their broker-dealer hat when discussing insurance with you.

You could argue that the ability of an advisor to switch hats should be prohibited by professional ethics, law, or both, but that isn’t the case. However, an advisor who is both a broker and a fiduciary is supposed to disclose to you every time they switch their hat. Regardless, this makes for a murky relationship from a consumer perspective, since you may have engaged an advisor because they presented themselves as a fiduciary. In cases like this, the expectation has been set for you as the client that you will always receive fiduciary advice. If your advisor switches hats to their broker role midway through a meeting with you, underlying conflicts of interest could suddenly come into play.

Always ask your advisor or investment manager if they are dually registered, and in which specific situations they operate as a fiduciary or broker, so you’re fully aware of the context of your relationship with them.

3. Determine how they receive compensation.

It’s essential to know the difference between broker and fiduciary compensation. As we’ve mentioned, a broker’s role is to facilitate transactions, operating under a broker-dealer. The difference between a broker and dealer is that a broker makes transactions for clients, and a dealer provides inventory to clients. Since a broker’s role is to help close sales, their compensation is often in the form of sales commissions based on the size or volume of their transactions.

The more complex a financial product, the harder it often is to sell, and the larger incentive a broker will receive as compensation for making the sale. Many illiquid, non-traded financial products such as annuities, master limited partnerships, real estate investment trusts, and structured notes come with high commissions, which can leave the door open to conflicts of interest. These products are also complicated for buyers (and even brokers) to understand.

In addition, confusion around the terminology for compensation is rampant in the financial industry. The distinction between fee-based vs. fee-only financial advisors is a common question that pertains to whether or not an advisor is a fiduciary.

Independent, fee-only advisors are almost always going to be fiduciaries. This is because they are always compensated solely by their client and solely for advice that is in the client’s best interest. In contrast, a fee-based compensation model means a firm (or licensed individual) can get paid by the client and through sales of products and commissions. People tend to think the terms “fee-only” and “fee-based” mean the same thing on paper, but in reality they’re different. Consumers must watch out for this.

Pro Tip: It’s critical to know whether the professional you’re working with is receiving commissions or a flat fee for selling you financial products. An excellent approach for finding a fiduciary is to seek out a fee-only advisor who earns compensation solely from their clients (rather than from a dealer) through an assets under management fee. This fee is a percentage determined by the number of assets the advisor manages for you. Other advisors may charge a flat or hourly rate, but the important factor is that they don’t receive commissions for selling you financial products.

4. Consider any potential conflicts of interest.

Legally, a fiduciary cannot act out of self-interest. If their advice carries any potential conflicts of interest, they’ll raise the issue with you as their client. In contrast, brokers act out of inherent self-interest. For example, investment brokers often only sell products that are available on their own platform. If their firm won’t benefit from you purchasing a particular product, the broker won’t sell it to you—even if it’s your best option.

Moreover, there are common situations in which conflicts of interest occur. Say, for instance, you want to weigh the pros and cons of paying off your mortgage early. You might ask your advisor if you can sensibly use money from your investment portfolio to pay it off. If your advisor cautions you not to go this route, a conflict of interest exists because the advisor’s fee is based on the amount of assets you have under management with their firm. This isn’t inherently negative; it just means that if they’re a fiduciary, they’re obligated to disclose the conflict to you, whereas a broker is not.

An advisor with your best interests in mind will ask what makes the most sense from a numbers perspective: paying off your mortgage, or leaving your money in your portfolio? What makes the most sense from a personal standpoint? Is there a trade-off in any other area of your life? They’ll walk through all the pros and cons with you and ultimately let you decide your preferred course of action. So, always be sure to ask your advisor how their conflicts of interest might affect you, and how they will address any conflicts.

Our Team Of Fiduciaries Puts Your Interests First

At Bay Point Wealth, we are SEC-registered fiduciaries, and we are legally mandated to uphold the fiduciary standard. In addition, all of our lead advisors are required to hold the CFP® designation and adhere to the CFP® Board’s code of ethics and practice standards.

Our team is proud to put our clients’ interests above our own when providing financial advice. We believe it’s the right thing to do. We’ll always work diligently to understand your objectives and create a financial plan or investment management strategy that meets your individual or family needs.

When you work with us, you also have the peace of mind of knowing we are a fee-only firm, which means we don’t take commissions. This drastically reduces the potential for conflicts of interest of any kind. In addition, we do everything in our power to illuminate all fees that our clients will encounter.

You and we are in this together: Our firm succeeds when we give advice that’s in our clients’ best interests. If you’re seeking a fiduciary advisor to help you reach your financial goals in the way that’s right for you, schedule a call with us today.

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Topics: Financial Planning