Fiduciary Standard vs Suitability Rule – Choosing a Financial Advisor

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Although the term fiduciary has been around for a very long time, most have not heard of it until recently. 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 what is called the “fiduciary standard”. Despite the enhanced visibility of the term ‘fiduciary,’ 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.

So what is a “Fiduciary” and what is its potential significance to you?

In lay terms, 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, there must be an optimal sense of working in your best interest, such as presenting financial products or funds that 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, collect all of your information, run a battery of 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.

The fiduciary standard is a high standard, indeed. Financial professionals who are Registered Investment Advisors are fiduciaries, who are held, by law, to extremely high standards of working fully in your interests – not in the interests of any company and not in their own interests. If they fail to do so, they could find themselves in serious trouble.

“Isn’t every financial professional held to this fiduciary standard?’ you might ask.

Consumers are often shocked to learn that the vast majority of people who are in the financial services professions are not held to the fiduciary standard. Instead they are held to a lower standard called the “suitability rule”.

I want to be clear that even though I serve my clients in a fiduciary standard, I know a number of good financial services professionals who are honest and 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 who are 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 is then obligated to read these disclosures, which are often voluminous, to make sure the financial product is right for them.

The problem: most people do not have the financial sophistication to discern if the financial product being offered is right for them.

Financial service professionals who are held to the suitability standard are not required to make sure the product is optimal, nor are they required to point out potential conflicts of interest that may be influencing their recommendation, such as compensation differences between various competing products.

It is important to point out here that some people possess a great deal of knowledge as it relates to financial matters. Therefore, working with financial service professionals who are held to the suitability standard can work for them. But if you are not in that category, you probably should look for a financial advisor who adheres to the fiduciary standard.

Fiduciary Standard or Suitability Rule?

If you are in need of a financial services professional, determine which of these standards you want the person you work with to be held to. 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.

Listen to our podcast for more on the fiduciary standard.

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