When it comes to providing financial advice, we like to think our advice is not unlike the “treatment” and advice doctors provide for our physical condition. But, instead of treating a torn achilles, a heart condition or the flu, we provide advice on “healthy” asset allocation, tax strategies and retirement projections, etc.
Recently, the Department of Labor has brought to light a concept known as “the fiduciary standard” which in the most basic terms means “always acting in the client’s best interest”. So in the medical field, it’s the equivalent of having the assurance that your doctor’s advice and recommendations are what’s best for you and not for them. On the surface, it makes perfect sense. Of course, the devil is in the details as it relates to someone who calls themselves a “fiduciary” as this is not a black-and-white question. Rather – there are shades of grey that must be defined in order for you to know exactly what kind of a fiduciary you are looking for. And we think the best way to illustrate this is to compare it with how we work with doctors.
We call this The Doctor Test and below we detail the four types of fiduciary. (Note: For a more detailed analysis and background on how these standards developed, feel free to read a recent and comprehensive post from Michael Kitces, a financial planning industry expert.) In short, we would like to see the financial industry operate with the same high ethics as the medical industry.
Keep in mind, each of the following types of advisors can certainly claim to call themselves “fiduciaries” just like a medical professional earns the right to call themselves a “doctor”. However, the TYPE of “fiduciary” or the means by which they practice is critical in evaluating whether your definition of a fiduciary aligns with your financial planner’s.
1. The “SEC” or State Registered Investment Advisor (RIA): This type of advisor complies with the Investment Advisors Act of 1940, which states they must not act in any way that is fraudulent or misleading. Sounds great right? BUT, this just means they must disclose their conflicts of interest, it doesn’t mean they don’t actually HAVE conflicts of interest. So they could be paid on commissions for recommending that mutual fund, they just have to disclose it in their filings. Did you really read the small print in the disclosure they provided?
The “Doctor” Test: You’re having chest pains and your doctor correctly diagnoses you need to take a particular prescription that would help treat the condition. He or she recommends an expensive drug even though there’s a generic alternative at a fraction of the cost. In the paperwork you signed, it says he could get taken on a fishing trip or a nice seminar in Barbados for recommending this drug. Would you be OK with that? Of course not, and that’s why doctors don’t operate in this manner.
2. The Department of Labor (DoL) Fiduciary: This advisor complies with the new DoL regulation that requires “always operating in clients’ best interest” when providing retirement advice. Again- sounds great. However, the problem is this standard only applies to investment advice on retirement accounts. It says nothing about broader financial planning topics and does NOT apply to non-retirement accounts. This makes no sense.
The “Doctor” Test: You’ve been experiencing knee pain and turn to a doctor for help. She evaluates your knee and recommends an effective knee brace (with no financial incentive) to help you alleviate the symptoms. But then you mention your aching back and while it could be directly related to your knee problems, she doesn’t have to provide the same heightened standard of advice and recommends an expensive, high-risk procedure to be performed by a doctor she gets a referral fee from. Any doctor we know would never practice like this. But just like our bodies are one system of interacting components, so are our financial accounts. It shouldn’t matter if one is classified as a retirement account or one is not!
3. The Certified Financial Planner ® Fiduciary: The CFP certification is an outstanding program as it is comprised of a rigorous series of education requirements, comprehensive (and very long) exam and continuing education which covers almost all aspects of personal financial planning. We are CFPs here at Magis Wealth Planning so we certainly endorse the high standards the CFP Board requires of its members. While the certification is a great start in evaluating a planner, it’s not a legal standard. Which means that to call oneself a CFP, you must pass their exam and agree to adhere to their Code of Ethics. That’s fine but what if a CFP doesn’t comply? There is no legal recourse. The CFP Board can’t fine anyone or subpoena anyone or force anyone to testify in a legal matter. Their only recourse is to strip a violator of the certification. While this might be detrimental, stripping one of their CFP mark does not preclude them from practicing as a financial planner.
The “Doctor” Test: Let’s say you’ve heard there is a doctor who has some high-level certification for rotator cuff surgery. Of course if you need that procedure, you would certainly seek them out. But what if he hasn’t kept up on the latest & greatest techniques and technologies associated with the surgery. What’s the risk to him? Well, he could lose that high-level certification. But with a solid reputation already established, maybe he might not care. But you would certainly care. The point is the downside risk to the doctor is not as equitable to you as it is to him.
4. The “Crystal Clear” Fiduciary: In our minds, this is the most stringent standard that we believe all people seeking financial advice should demand. These are financial advisors who usually are members of networks of like-minded advisors such as NAPFA & Alliance of Comprehensive Planners (full disclosure: we are member of both organizations) which actually document and sign a contract with clients which explicitly states on paper they are ONLY compensated by client fees and there are no other means of compensation like commissions, referral fees or golf-junkets to the Bahamas for selling annuities.
The “Doctor” Test: We wish we could walk into a doctor’s office or a hospital and among all the paperwork we have to fill out (over and over again, it seems), see an explicit declaration that this doctor is only compensated by what we pay them and their medical advice is not “clouded” by potentially more lucrative recommendations from third parties. We’re confident doctors actually do operate without the conflicts, we just wish the same were true for the financial industry.
The point is this: The advice business, be it medical or financial, can be confusing enough with all the acronyms and esoteric terminology. What should be completely transparent is the compensation model that may or may not be driving recommendations from our practitioners. In short, we would like to see the financial industry held to the same high standards as the medical industry.
We think a great way to cut through the confusion on all the standards, acronyms and certifications is to simply apply the “Doctor Test” when evaluating a financial advisor. This should go a long way toward aligning your physical health with your financial health.