What Are the “Standards of Care and Protection” Offered by Financial Advisors?

The last blog post, “How Is Your Financial Advisor Compensated?” described the three main types of advisors and how they operate. A key point was that not all advisors have to work solely in your best interests.

Imagine if a physician wasn’t legally required to act solely in your best interest?   Luckily, the law requires physicians to act as fiduciaries, but as hard as it is to believe, not all financial advisors are required to. Why are some advisors required to act in a fiduciary manner, while others have a lower standard and only need to meet a “suitability standard” of care?

First, we must understand what it means to have a fiduciary duty. According to the Financial Planning Coalition, “The fiduciary standard of care requires that a financial adviser act solely in the client’s best interest when offering personalized financial advice.” This standard means that if there are two comparable investments, and one pays an advisor a higher commission and the other one offers the client lower fees, that the investment with the lower fees must be selected.

Many people automatically assume that every financial advisor has a fiduciary duty to the client and will put the client’s needs ahead of their own. But believe it or not, financial advisors have two different levels or standards that are used when advising clients.

Understanding the Differences between
Suitability and Fiduciary Standards

Financial advisors and their companies will either operate under the suitability standard or the fiduciary standard, or some combination of the two. In our opinion, the Fiduciary Standard is superior and provides the public with the most protection.

Suitability Standard

Suitability Standard is the measure of selecting products that meet the client’s needs based on their objectives, means, and time frame for investing. It does not require the advisor to select the very best product for the client, only a product that is suitable. The suitability standard provides advisors with the ability to sell investments that pay higher commissions, even if other, lower costs products are available to the client. Many brokerage firms have proprietary investment options that they want the brokers or financial advisors to choose for their clients’ portfolio and often create financial incentives in the form of higher commissions to motivate advisors to recommend these products to clients. They use the suitability standard because it provides advisors with the flexibility of promoting the company’s products, or other expensive managed funds, even if it may not be the best investment for the client.

Fiduciary Standard

This provides clients with a higher level of unbiased advice because of the obligations and responsibilities that the financial advisors have with the client. Below is an explanation of the fiduciary standard by the Financial Planning Coalition:

“The fiduciary standard of care requires that a financial advisor act solely in the client’s best interest when offering personalized financial advice… Consumers are harmed by the absence of a uniform fiduciary standard that applies to all financial professionals who provide personalized investment advice, from paying excessive fees and commissions to receiving substandard performance. Consumers are exposed to even greater and unnecessary risks from products that may be deemed suitable for them but are inferior to other available options and not necessarily in their best interests.”

These two standards impact investors significantly. The challenge for the public is distinguishing between the two. With a varying array of professional titles and financial services offered, it is often not clear, which standard the financial professional is using. Fiduciary advisors will tell you that they are a fiduciary 100% of the time. If your advisor has not told you what standard of care they work under, then just ask. If the advisor wears both the suitability and fiduciary hats, beware. Ask yourself why they sometimes take off the fiduciary hat. Does that mean that that something not in your best interest is heading your way?

Understanding the difference allows clients to arm themselves with the information needed to ensure their advisors are looking out for their best interests. So, when choosing a financial advisor, you should seek a relationship that falls under the fiduciary standard 100 percent of the time. While this topic can be confusing, it is an important distinction when choosing a financial advisor.

It is also important to understand what real professional financial planners do and the services they offer.  In our next blog post, we will discuss the services professional fiduciary advisors offer and clear up some misconceptions about what financial advisors actually do.