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Fiduciary at work

Finding the best investment advisor depends on understanding a few terms of art. Two particularly key terms retail investors are likely to run across when looking for an expert to help with investments are “fiduciary” and “suitability.” The terms describe the standard of care and behavior that investment professionals are expected to follow when dealing with investors. Although they sound similar, they describe quite different standards. Investment experts who follow the fiduciary standard are required to put their clients’ interests ahead of their own. Those who conform to the suitability standard just have to make sure their recommendations are suitable, given the client’s age, goals, resources and other factors. Learn the distinctions between the two here.

In practice, often the difference between the fiduciary standard the suitability standard comes down to how much financial benefit the investment professional stands to get from a recommendation. Given a choice between recommending one of two virtually identical – or even similar – investments, one being a low-cost option and the other carrying a sales commission for the professional, the fiduciary is required to recommend the lower-cost option. The suitability standard, meanwhile, may let the recommender point the investor toward the higher-profit option, even if it means the investor will pay more and therefore is likely to get a lower total return on his or her money.

Fiduciary Fine Points

The fiduciary standard to act only in the client’s best interest is the same as the one that attorneys and medical doctors follow. In the financial world, this code calls on the financial counselor to fully disclose any conflicts of interest, including whether one recommendation pays a higher commission than another that is virtually the same, except for the commission. The advisor is further required to make sure that any conflicts that do exist don’t affect the advice given.

The fiduciary standard can’t be waived. Investors are commonly asked to sign agreements with their advisors that describe the terms of their arrangement. However, nothing in one of these agreements is valid if it would allow a fiduciary to follow a lesser standard.

Suitability Details

The suitability standard recently got an overhaul when the Securities and Exchange Commission (SEC), in 2020, began requiring stock brokers and investment dealers to follow what’s known as a best interest standard. While this does tighten standards for stock brokers and dealers, it does not protect investors as well as the fiduciary standard.

Because the rule change is recent, it’s still not clear how the issue of recommending higher-cost investments is affected. As is, some brokers may be able to recommend choices that put more money in their pockets as long as they meet certain disclosure requirements. This may change, however, as the implementation and oversight of the rule evolve.

Identifying a Fiduciary

Five financial fiduciariesInvestors attracted by the idea of getting advice from someone who won’t recommend high-priced investments for personal profit motives may prefer to choose a fiduciary. One way is to use a registered investment advisor (RIA). Ever since 1940, when the Investment Advisors Act was passed, investment counsellors registered with the SEC as RIAs have to follow the fiduciary standard.

Part of the 2020 SEC rule change prohibits brokers and dealers, who follow the suitability standard, from advertising themselves as “investment advisors.” So using only an expert who displays that term in marketing materials is one way to increase the chances of getting fiduciary-level service. However, some professionals may be registered as both advisors and brokers, and may follow the less-strict standard in certain circumstances.

Another way to make sure an investor is getting advice from a fiduciary is to see that the advisor has a designation as a certified financial professional (CFP) or chartered financial analyst (CFA.) People with these designations are obligated to follow the fiduciary standard.

While it’s not directly related to the fiduciary or suitability standards, another path to reduce conflicts of interest is to choose an advisor who has a fee-only business model. Note that fee-based is not the same as fee-only. This means the advisor doesn’t get commissions for selling investment products. Instead, the advisor charges the client directly through flat fees for such services as preparing a financial plan, through monthly or annual service charges or by charging a percentage of the assets being managed. A fee-based advisor, on the other hand, can earn sales commissions from third-parties such as insurance companies and mutual funds on top of what a fee-only advisor would earn.

Finally, an investor could ask a financial professional to sign a code of ethics requiring the professional to follow the fiduciary standard. The Institute for the Fiduciary Standard has a sample code of ethics that investors could use for this purpose.

Bottom Line

Fiduciary meeting with clients

The suitability standard and the fiduciary standard are two requirements placed on different investment professionals. The fiduciary standard requires RIAs and some others to only make recommendations that are in the client’s best interest. The suitability standard requires only that investments be suitable to the investor’s circumstances, and may allow a broker to recommend an investment that is more costly and generates a higher commission than a similar low-priced option.

Tips for Investing

  • Any time you are considering making an investment decision, it’s a good idea to talk it over with an experienced financial advisor. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • One of the ways to get completely free, unbiased advice about how to put your hard-earning dollars to work is by using an investment calculator and asset allocation calculator.

Photo credit: ©iStock.com/gradyreese, ©iStock.com/EHStock, ©iStock.com/AlexRaths

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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