If you’re searching for investment advice, you’ll probably be confronted with many choices. You’ll encounter service providers with titles like “certified financial planner,” “financial consultant,” “registered investment advisor,” “stockbroker,” and “insurance agent,” among many others
These titles can be confusing. And, what’s worse, they don’t give you a clear picture of who has your best interest in mind. But don’t worry, there is a way to figure that part out.
Do You Know the Difference Between Fiduciary and Suitability?
The Department of Labor (DOL) recently announced an overhaul in its regulation of financial advice on retirement savings. Central to this discussion are two terms: fiduciary and suitability.
What does it mean for an advisor to operate on a fiduciary standard, and how does this differ from a suitability standard?
The Fiduciary Standard
The DOL describes a “fiduciary” as an advisor who is required to put clients’ best interests before their own profits. Fiduciaries include three types of people:
- Registered investment advisors (like McLean Asset Management)
- Advisors to mutual funds (like Dimensional Fund Advisors or Vanguard)
- Others who hold themselves out to be fiduciaries (trustees and certain retirement plan consultants)
Fiduciaries must act impartially. They must act with the care, skill, prudence, and diligence that a prudent person would in the current circumstances. A fiduciary must avoid conflicts of interest and misleading statements about fees.
Fiduciaries are typically compensated by fees rather than commission. The DOL actually has rules in place that prohibit fiduciaries to retirement plans, plan participants, and IRAs from receiving payments that create conflicts of interest, unless the payments fall under certain exemptions issued by the DOL.
Not only that, but you can expect a fiduciary to act with transparency. Presented with two comparable investment choices, a fiduciary would typically recommend the option with lower management fees.
Fiduciaries are personally liable for breaches of their fiduciary duties. If a breach of their fiduciary duty caused a loss, the fiduciary would be required to make the plan or IRA whole by restoring any losses caused by the breach and restoring any profits to the plan or IRA made through the use of plan or IRA assets.
Breaches could be addressed in the form of civil actions by a participant, beneficiary, fiduciary, or the U.S. Secretary of Labor. The fiduciary may also be subject to excise tax penalties.
The Suitability Standard
The suitability standard is used by representatives of a broker-dealer to judge the suitability of a product for clients.
Under securities laws, suitability is based, for the most part, on a client’s financial goals, income, and age. The rules do not legally require many of the other things that come with a fiduciary’s advice, including:
- Recommendation of the most cost-effective product,
- A disclosure of conflicts associated with the investment, and
- A disclosure of the compensation received when making that recommendation.
What this really means in practice is that a recommendation can’t be gratuitously bad. There needs to be some possible justification for the recommendation – though it doesn’t need to be a good justification.
New DOL rules may mean common forms of broker compensation, such as commissions and revenue sharing, will be restricted.
Why the Move to a Single Standard Is Good for You
Many financial advisors are dual-registered as both brokers and investment advisors. This can make it difficult to determine if an advisor is acting under the fiduciary or suitability standard. The DOL’s new rules aim to create a single standard for retirement financial advice based on a fiduciary model.
Depending on who handles your wealth, you might already receive fiduciary advice. If that’s the case, the change won’t impact you much.
Following the new DOL rule, all sources of professional financial advice for retirement assets could be subject to a level fiduciary standard. But, as with any investment advice, you should conduct your own research, ask questions, and learn more about the reputation and philosophy of an advisor.
Note that in certain circumstances, information provided by advisors or brokers may not be treated as fiduciary advice. Here are some examples of exceptions from the new DOL rule:
- General investment education
- Simple orders (in which your advisor executes an order to buy or sell without providing a recommendation)
- Certain “robo-advice”
For more information on finding a retirement service provider who operates under the fiduciary standard, download our ebook, “The Value of a Retirement Plan Advisor.”
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