Definitions are easy to come by in the Internet age. Investopedia defines a fiduciary as a person or organization that owes to another the duties of good faith and trust. The highest legal duty of one party to another, it also involves being bound ethically to act in the other’s best interests.
Further, Investopedia states that the fiduciary is expected to manage the assets for the benefit of the other person rather than for his or her own profit, and cannot benefit personally from their management of assets.
The Investopedia list of fiduciaries includes money managers, bankers, accountants, executors, board members, and corporate officers. Other definitions add mortgage brokers and real estate agents to the list.
Please note that some of these occupations are compensated on an hourly basis, some charge a fee for service while others earn commissions. Commissioned occupations are strongly motivated to upsell, that is, to sell more than their clients need, as everyone either knows or strongly suspects.
Let us look at the first occupation on the Investopedia list, namely, money managers.
Globally, in many jurisdictions, money managers have no legal fiduciary responsibility but only an ethical one. That is, they are “expected to manage the assets for the benefit of the other person rather than for his or her own profit, and cannot benefit personally from their management of assets.” In other words, they are expected to put the interests of their clients ahead of the interests of their own children. They are expected to be saints. Now, how realistic is that?
To gain trust, online discount brokerage firms have abandoned the traditional compensation model of working on commissions. Unbeknown to most of their clients, money managers at these firms are motivated to upsell using another system.
Writing in the Wall Street Journal on January 10, 2018, Jason Zweig and Anne Tergesen published an article titled Advisers at Leading Discount Brokers Win Bonuses to Push Higher-Priced Products.
I quote: “At Fidelity, Schwab and TD Ameritrade, employees win extra pay and other incentives to put clients in products that are more lucrative for them, and the firm.”
“Fidelity representatives are paid 0.04% of the assets clients invest in most types of mutual funds and exchange-traded funds. They earn more than twice as much, 0.10%, on choices that typically generate higher annual fees for Fidelity, such as managed accounts, annuities and referrals to independent financial advisers.”
Knowing literally hundreds of options available to clients, financial planners could narrow that down to 20 suitable ones. Some of these would earn a planner and the firm more than twice as much as others and, of course, cost clients more than twice as much.
Smart money knows how to protect itself from these legal but morally questionable practices. Innocent money, that is, most retail investors are victimized. One of the seven habits of the highly successful investors is to be a self-directed (do-it-yourself) investor. That offers absolute protection from being victimized by financial adviser incentives.