A fiduciary is legally required act in your best financial interest and not their own - here's why that's so important

• Fiduciaries are legally obligated to act in their clients' best interests instead of their own.
• You should always work with a financial advisor who is a fiduciary.
• Breaches of fiduciary duty come with strict legal penalties.

Understanding the ins and outs of investing can be overwhelming, especially for those new to it. Should I invest in blue-chip stocks? How can I best diversify my portfolio? These questions may be best-directed at fiduciary financial advisors.

A fiduciary is anyone who must act in the best interest of a client or customer. Attorneys, bankers, and company board members are all examples of fiduciaries. Because they're legally required to maintain the best interests of their client, they offer a higher level of trust to those who work with them.

Let's take a closer look at what makes a fiduciary, how the fiduciary duty differs from the suitability standard, and how to find a fiduciary you can trust with your money.

What is a fiduciary?

A fiduciary is a person or organization that has agreed to act on behalf of customers, clients, or shareholders, facing legal consequences if they fail to do so.

A fiduciary is typically one who manages the assets of a client, although this isn't always the case. A fiduciary can come in many forms, including an accountant or company board member.

There are numerous types of financial advisors with different certifications, like Certified Public Accountant (CPA), Certified Financial Planner (CFP), and Financial Risk Manager (FRM), to name a few. It's important to note that it's generally up to the client to verify whether an advisor carries fiduciary status. For example, advisors with titles like "wealth advisor" or "financial advisor" might sound legitimate, but don't necessarily mean they're a fiduciary.

One of the easiest ways to verify whether a financial professional has fiduciary status is by working with a CFP, a trade-industry designation that necessitates a "fiduciary duty" to their clients along with practical financial experience and ongoing certification requirements.

Fiduciary duty vs. suitability standard

There are are two standards of care that apply to financial planners: the fiduciary duty and the suitability standard. They may seem similar, but it's important to know the difference.

A fiduciary duty is the legal obligation of one party to prioritize the interests of others. This relationship is between the principal (you, the client) and the fiduciary, such as a registered investment advisor (RIA). This is regulated by the SEC and is defined by the duties of loyalty and care.

Investment advisors have a fiduciary duty to their clients, which was established by the Investment Advisers Act of 1940. This means they must act under their clients' best interests.

Fiduciary duties tend to fall under two main categories:

• Duty of loyalty. This requires fiduciaries to prioritize the interests of their clients before their own, avoiding potential conflicts of interest that may impact their ability to make good decisions.
• Duty of care. This holds fiduciaries to a high standard of care, requiring that they make decisions prudently and in good faith. This duty can either be implicitly stated or spelled out in a contract, but it essentially requires professionals to exercise good judgment and make informed decisions.

Breaches of fiduciary duty happen when either of these two duties is not met, and such transgressions often result in the fiduciary losing their role of trust, along with facing a financial penalty.

In contrast, the suitability standard is a similar, but a less stringent guideline that applies to independent broker-dealers who aren't always governed by a fiduciary duty. Although broker-dealers are held to a fiduciary standard by some states, they're generally governed by much looser guidelines that must give them a "reasonable belief" that an investment or transaction would benefit the customer.

This "reasonable belief" is known to open the door for them to recommend investments that may cost more and earn them a higher commission than similar, cheaper investment alternatives, unlike fiduciaries, who must always act in your best interest.

Types of fiduciary relationships

There are numerous types of fiduciary relationships, and they aren't just limited to the world of investing. Here are a few:

• Financial advisor and client. In this relationship, the fiduciary has access to and control of your money, often with the clearance to make discretionary investment decisions, or decisions without your approval.
• Guardian and ward. Because minors are not able to legally make their own decisions, wards are fiduciaries who make decisions on behalf of individuals until they reach adulthood. Similar to financial fiduciary relationships, the guardian is entrusted by the government to prioritize the ward's best interest when making decisions.
• Attorney and client. This relationship comes with a significant level of trust and responsibility, because attorneys have access to a lot of their clients' private information. Because of this, breaches of fiduciary duty in these instances are heavily punished.
• Board and shareholders. Board members are responsible for guiding a company's future, meaning they must act in the best interest of shareholders when making decisions. To do so, board members have to explore every option available before making any decisions that would impact the future of said company.

How to find a fiduciary financial advisor

Now that you understand the value of a fiduciary, here are a few tips on how you can find the fiduciary financial advisor who's right for you:

• Reach out to friends and family for recommendations. If they direct you to a professional, be sure to ask whether they're fiduciaries.
• You can search and confirm whether a financial advisor is a registered fiduciary by using the SEC's advisor search tool.
• If you have doubts about a potential advisor's qualifications or commitment level, you can request that they sign a Fiduciary Oath. True fiduciary advisors should have no problem agreeing to this, and those who avoid doing so might not be appropriately qualified.

Note: Another option for those seeking investing guidance is using an automated robo-advisor. They are recognized by the SEC as fiduciaries, but they have many limitations you should weigh before electing to go that route.

5 questions to ask a potential advisor

In the vetting process, there are a few questions you should consider asking to ensure they'll offer investment and portfolio management advice with your best interest in mind:

1. "How do you earn money?"
   Different advisors offer varying fee structures, and a complicated fee structure might be not the best sign. Fee-only advisors don't get commissions, and this compensation method is considered the most transparent and objective.
2. "What certifications do you have?"
   Given the range of qualifications that an investment advisor can have, it's best to seek out those with a CFP designation. You can check professional status via the Financial Industry Regulatory Authority's professional designations database.
3. "Who's your typical client and what do you help them with?"
   Look for advisors who have experience successfully guiding clients with goals similar to your own.
4. "How do you prefer to communicate with clients?"
   You should have a clear understanding of how often you can expect to meet with your advisor, and whether that'll be via phone, email, or only by appointment.
5. "What investment benchmarks do you use?"
   It's important that advisors measure their success with benchmarks that are relevant to their investments, and many use the S&P 500 to gauge their equity performance.

Understanding a potential advisor's educational background, work history, and pay structure facilitates transparency and compatibility. It's important to trust who you're working with, since they'll be making important decisions on your behalf.

The financial takeaway

A fiduciary is an individual with a legal obligation to act in the best interest of a client or customer. In the finance world, a fiduciary typically manages a client's assets, and it's important to verify whether a financial advisor carries fiduciary status, because not all licensed financial professionals are regulated as fiduciaries.