Benefit vs. Suitability: Know the Difference

If you are looking for an investment advisor, you should be aware of these two terms

Fiduciary Standard

The fiduciary standard was established in 1940 as part of the Investment Advisers Act. This standard, which is regulated by the Securities and Exchange Commission (SEC) or state securities regulators, requires investment advisors to adhere to a standard that mandates putting their clients’ interests ahead of their own. The following rules fall under the fiduciary standard:

• The advisor must prioritize the client’s interests over their own.
• The advisor is prohibited from purchasing securities for themselves before buying them for the client.
• The advisor must make every effort to ensure that investment advice is based on accurate and comprehensive information.
• The advisor must avoid conflicts of interest. As a fiduciary, they are required to disclose any potential conflicts of interest.

If an advisor who is considered a fiduciary fails to adhere to any of these rules, it may constitute a breach of their fiduciary duty. Clients of the advisor may have the ability to file a lawsuit for damages if a breach of fiduciary duty results in financial losses.

Who is a Fiduciary?

Technically, a fiduciary is anyone who is tasked with making investment or financial decisions or managing assets on behalf of their clients. For example, if you establish a trust as part of your estate plan, the trustee you appoint can be considered a fiduciary.

From a financial advisory perspective, a fiduciary can be an individual financial advisor or an investment firm that employs the advisor you work with. Registered investment advisors (RIAs) fall under the fiduciary standard. RIAs are required to register with the SEC and file Form ADV.

This form is a public disclosure document that outlines how the advisor is compensated, their investment strategy, and any past or current disciplinary or legal actions taken against them. You can search for and review the advisor’s disclosure using the SEC’s electronic database.

Note: Registered investment advisors can also hold other professional financial designations. For instance, an RIA can also be a Certified Financial Planner (CFP) or a Chartered Financial Analyst (CFA).

Suitability Standard

Although the two terms may seem similar, there is a difference between suitability and fiduciary. Suitability simply means making recommendations that align with the client’s underlying interests. Here’s what you should know:

• Instead of prioritizing their own interests below those of the client, the suitability standard only requires the advisor to believe that any recommendations made are suitable for the client concerning their financial needs and goals and unique circumstances.
• Suitability means ensuring that transaction costs are not excessive or that the recommendation is not unsuitable for the client. More commissions may be generated through excessive trading or frequent shifting of account assets to generate transaction income for the advisor.
• There is no requirement to disclose potential conflicts of interest to the same extent required under the fiduciary standard. The investment only needs to be suitable for the client, not necessarily consistent with the goals and profile of the individual investor. Fee-based advisors may be incentivized to sell their own products over competing lower-cost offerings. This is how they earn commissions.

Which Advisors Follow the Suitability Standard?

The suitability standard is typically associated with brokerage firms. A broker is an individual or company that facilitates the trading of securities for their clients. For example, if you have a retirement account with a brokerage firm like Fidelity or TD Ameritrade, those companies are examples of brokerage firms. You tell them which investments you want to buy or sell in your portfolio, and they handle the transaction.

Conclusion

If you are interested in finding a fiduciary investment advisor, a great place to start is to look for a fee-only financial planner. Fee-only planners do not sell products and do not earn commissions. They charge flat fees and are not incentivized to sell any kind of product. Their advice is held to the highest standards of quality, and they must put their clients’ interests ahead of their own.

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Different from fee-based advisors, fee-only advisors earn their money through a combination of fees and commissions. This means that if you purchase a specific investment they recommend, they earn a percentage of the amount you invest as a commission. To find a fee-only financial planner near you, check the National Association of Personal Financial Advisors.

Source: https://www.thebalancemoney.com/difference-between-fiduciary-and-suitability-4010117