Fiduciary Standard vs Suitability Rule – Choosing a Financial Advisor

Fiduciary Standard vs Suitability Rule - Choosing a Financial Advisor

Although the term fiduciary has been around for a very long time, most have not heard of it until recently.

Back in 2015, our former president and the Department of Labor decided that it was in the best interest of the nation to hold financial professionals who provide advice to the public as it relates to their retirement accounts, to the fiduciary standard.

Despite the enhanced visibility of the term, many people still aren’t entirely clear about its definition, let alone how the term impacts their own financial situation or choosing a financial advisor.

What is the fiduciary standard?

The fiduciary standard means that the highest priority is to recommend investments in their client’s best interests, not their own.

A fiduciary is someone who — by law:

  • Has to put your best interests ahead of their own
  • Must avoid conflicts of interest, and
  • Must disclose such conflicts when they exist (sometimes conflicts of interests are unavoidable).

With a fiduciary, they are working in your best interest. When they present financial products or funds, they have reasonable fees.

Think of it in much the same way that you would think about a doctor. The doctor is under an obligation to work in on your behalf. They would collect all of your information, run tests seeking as much detail and understanding as possible, and then make recommendations in your best interest.

And likewise, financial professionals should operate in the same way.

Are all financial professionals fiduciaries?

The fiduciary standard is a high standard, indeed. Registered Investment Advisors are fiduciaries. They work in your interests and not in the interests of any company or themselves. If they fail to do so, they could find themselves in serious trouble.

The vast majority of financial services professionals are not held to the fiduciary standard. They are held to a lower standard called the suitability rule.

That does not mean most financial professionals are not honest. I know many that put their clients’ best interests ahead of their own, even though they are not required to by law.

What is the suitability rule?

I like to think of the suitability rule as a modified “buyer beware” standard. Financial service professionals held to the suitability rule only have to:

  • Make a cursory inquiry into a customers financial situation when they are recommending a financial product.
  • Supply that customer with written disclosures about the risks.

The customer must make sure the financial product is right for them by reading these disclosures. And we know how much we read the volumes of fine print. Unfortunately, most people do not have the ability to discern if the financial product being offered is right for them.

Financial service professionals are not required to make sure the product is optimal if only held to the suitability standard. They are also not required to point out potential conflicts of interest influencing their recommendation such as compensation differences between various competing products.

It is important to point out that some people possess a great deal of knowledge as it relates to financial matters. In this case, a financial service professional that is held to the suitability standard may be right for them. But if you are not in that category, you probably should look for a financial advisor who adheres to the fiduciary standard. Listen to our podcast for more on the fiduciary standard.

Protecting your retirement savings

Take the following steps on your own behalf:

  • Ask your advisor if they adhere to the fiduciary standard. If they do they will tell you right up front and will acknowledge it in writing. If they don’t they will dance around the question.
  • Find out if a Registered Investment Advisor (RIA) is helping to administer your company’s 401k plan. RIAs generally serve in a fiduciary capacity, but not always so be cautious as some can function as both a registered investment advisor and a broker.
  • Be aware of your options during transition times, such as changing jobs or retiring. Don’t simply roll over your money just because a commission hungry financial person tells you it’s a good idea. Sometimes it can be a good idea to do so but many times it may not.

Fiduciary Standard or Suitability Rule?

If you need a financial service professional, choose the professional that adheres to the standard that makes the most sense for you. This is an important step in choosing the ideal financial professional for you. One last thought, if you want to work with a fiduciary, make sure you have a signed contract that states clearly that they are working in this capacity.