RENO, Nev. — Fiduciary and suitability may sound similar, but they couldn’t be more different when looking at what they mean in the financial services industry.
Up until recently, these two words weren’t in most individual’s everyday vocabulary. The increase in popularity is a result of the Department of Labor’s Fiduciary Rule initiated in 2016.
Proposed reforms targeting the financial services industry have been circulating since 2010 but it wasn’t until then President Obama proposed the first major overhaul in 40 years that shocked the industry.
The purpose of the new legislation, passed in 2016, was to require that anyone giving financial advice put the interest of their clients ahead of their own and to eliminate as many conflicts of interest as possible.
Seems logical right? Well, it should come as no surprise that brokers and their employers are not fans of this new legislation. Large Broker-Dealers have spent tens of millions of dollars lobbying Congress trying to get the Fiduciary Rule amended, delayed or overturned, claiming it will cost them money in both lost commissions and increased compliance expenses.
Others argue the fight is for other reasons. According to a 2015 report by the White House Council of Economic Advisors, biased advice drains over $17 billion a year from retirement accounts.
The billions of dollars drained from these retirement accounts from various types of fees flowed straight into the pockets of the brokers and their employers. Others also argue that the new legislation didn’t go far enough and should include all investment accounts and not be limited to just retirement accounts as passed.
Our goal is not to bash brokers and those held under the suitability standard but rather to shed light on the new shake up in the financial industry. There are a lot of very good brokers in the financial industry doing great things for their clients.
The purpose of this article (and of the new legislation) is to identify and eliminate the clear and present conflict of interest for those brokers looking to take advantage of archaic regulatory oversight.
What’s the Difference?
Fiduciary
The fiduciary standard was created as a part of the Investment Advisor Act of 1940. This standard, which is regulated by either the SEC or state securities divisions, maintains that investment advisors are bound to a standard that requires them to put the interest of their client’s ahead of their own.
One major benefit to working with a fiduciary is that fiduciaries must try and avoid all conflicts of interest. If a conflict exists, an advisor must disclose the conflict prior to making recommendations.
Suitability
The suitability standard requires that brokers make recommendations that are suitable based on a client’s personal situation, but the standard does not require the advice to be in the client’s best interest.
This standard is regulated and enforced through a self-regulatory organization called Financial Industry Regulatory Authority (FINRA).
Why Does It Matter?
So, what does all this mean to you, the client? Consider the following hypothetical situation. Say your advisor or broker is working under the suitability standard and is recommending a mutual fund for your portfolio.
Let’s assume he or she is deciding between two funds, one is “good” but the other is “great.” The “good” mutual fund pays a commission of 3% up front but the “great” fund only pays a 1% commission up front. Chances are you, the client, will be owning the “good” mutual fund in your portfolio.
The idea of giving up 2% of commissions to an advisor who is compensated based on commissions, is asking a lot of an individual. This is what is called a conflict of interest. Now let’s use this same example but look at it under the fiduciary standard and it’s pretty simple.
Because the advisor must put your interest ahead of their own, you would be owning the “great” mutual fund in your portfolio, regardless of what the advisor would make off the transaction.
Taking this one step further, there are what the industry calls “Fee-Only” advisors. These advisors charge a management fee, typically a percentage of the assets they manage, and it’s the only fee they receive.
No commissions, no loads, sales charges, 12b-1, etc. Again, using the example from above, you would no doubt be owning the “great” fund because the advisor wouldn’t even take the commissions into consideration being that their only compensation is from the management fee.
Are you working with a fiduciary?
Working with a Registered Investment Advisor (RIA) will ensure that you are working with an advisor who is held to the fiduciary standard.
The best way to find out whether you’re working with an RIA is to simply ask your advisor if they are a registered representative working for a broker-dealer (broker) or a Registered Investment Advisor.
Kyle McCann and Benson Mathews are Certified Financial Planner professionals with Reno-based Vantage Wealth Planning, a fee-only Registered Investment Advisory firm that works with individuals, families and small business owners with all aspects of their financial planning needs. Visit www.vantagewealthplanning.com to learn more.
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