Headline: You Have to Have Some Standards

Date: 1/1/2021

Body: This one’s a little different.  I was listening to NPR today, and specifically, I was listening to a podcast that was speaking about the standards we have to deal with in the financial sector.   Constantly repeated were the terms “suitability standard” and the very different “fiduciary standard.”   Given the New Year, I thought this was a very appropriate subject.

What is a fiduciary and what is the “fiduciary standard?”

A fiduciary is anybody entrusted to make investment or money decisions for the benefit of clients.   To enforce this trust, the government (particularly, the SEC) requires these professionals to do or not do certain things.  For example, an advisor is prohibited from buying the same stock for their own account BEFORE investing in the same stock on behalf of their client. . Additionally the fiduciary is required to use the “best execution” method, optimizing the combination of cost and efficiency of each trade. There are some other requirements too, but basically, they are legally required to subordinate their own profit to the cause of their clients’ profit, if they are under the fiduciary standard.  If they fail in this requirement, they can be sued.

There have been changes in the modern day

A 2016 ruling from the Department of Labor required a large new group, retirement specialists, adhere to these standards.  This is important because if they are not held to this standard, these brokers can select securities that offer them a better commission rate.  This subordination of priorities would be perfectly legal under the “suitability standard.”

What is a “suitability standard?”

The fiduciary standard is a very high standard of care required of some professionals.   The suitability standard is somewhat less stringent, and often is the standard to which brokers are held.   To make it more concrete: consider an example.  Client A is a conservative investor, who only invests in stocks and bonds or mutual funds.   Under a Suitability standard, the broker-dealer can invest in any stock, bond or mutual fund, and are permitted to suggest investments that might be sub-optimal for the client, but would bring them a larger commission.  Under a fiduciary standard, this behavior would not be permitted, and the broker would be required to invest only in the things that are best for their clients, under the circumstances that are best for the client.   It might be more helpful to see these standards side-by-side.

AttributeSuitability StandardFiduciary Standard
Transaction CostsTransaction costs cannot be excessive.“Best execution” must be followed and costs must be minimized.
Transaction Frequency“churning” moving from investment to investment for the purpose of increasing fees is sometimes OK.This is not permitted.
Conflicts of InterestPotential conflicts of interest SHOULD be disclosed.Potential conflicts of interest MUST be disclosed
Investments PermittedThe Broker may invest in a broad array of investmentsThe Broker can only invest in investments consistent with the investing profile of the client.
Personnel AffectedBroker-dealersCPAs and retirement professionals.

The Verdict

The importance of this topic is somewhat elusive, but it really is key to your bottom line as an investor.     The common investor must be constantly aware of the standard to which their advisor is being held.  This can be tough sometimes, because broker-dealers are so numerous, and advisors under the more stringent fiduciary standard can be thin on the ground.   As a result, it might appear that the broker-dealer is the professional to use, as they tend to offer cheaper service.  But, I urge you to consider getting information and services from a professional under the fiduciary standard, because in the long-run, you will likely make more  money with these professionals than the brokers because they minimize transaction fees.  Further, the investments made by these professionals are  required to be consistent with the investing philosophy of the client.  As a result, you might be able to sleep a bit better, if you use a professional who has to abide by this more strict standard.


Fiduciary vs. Suitability: Know The Difference (thebalance.com)

Suitability vs. Fiduciary Standards: What’s the Difference? (investopedia.com)

What Is a Fiduciary? (fool.com)

What Is a Fiduciary? – NerdWallet

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

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