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Fiduciary vs Suitability Standard

Summary:
Today we hear the word fiduciary tossed around as some concept that means the same thing by everyone who utters it. Nothing could be further from the truth. A fiduciary, according to Investopedia is:   … a person or organization that acts on behalf of another… putting their clients’ interest ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other’s best interests.   Well, you say, shouldn’t anyone who handles my money act in my best interest, whether they carry the title of advisor, adviser (yes one letter makes a difference), manager, or representative? Of course, they SHOULD, but not everyone does. There are two terms in the world of investing that often get confused; the suitability

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Today we hear the word fiduciary tossed around as some concept that means the same thing by everyone who utters it. Nothing could be further from the truth. A fiduciary, according to Investopedia is:

 

… a person or organization that acts on behalf of another… putting their clients’ interest ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other’s best interests.

 

Well, you say, shouldn’t anyone who handles my money act in my best interest, whether they carry the title of advisor, adviser (yes one letter makes a difference), manager, or representative? Of course, they SHOULD, but not everyone does.

There are two terms in the world of investing that often get confused; the suitability standard and the fiduciary standard. They sound a lot alike. They can certainly be confused as meaning the same thing. But dig down and you’ll find separate definitions. And unless you know the meaning of each term, you may hire someone to advise you about your portfolio based on mistaken identity.

You find the suitability standard at work among investment representatives and investment brokers who work for broker-dealers. Those individuals have a “suitability obligation,” which means they make recommendations they believe are suitable for your situation. But just because a transaction is suitable doesn’t necessarily mean it’s appropriate. Let me give you an example.

When dot-com stocks were blowin’ and goin’ in the late ’90s, I watched brokers put clients into large positions of those stocks because the client’s net worth was high enough “to absorb any losses” that might occur. By the legal definition, those trades were suitable because of a high net worth. But some of those clients had moderate to moderately conservative risk profiles. So, just because it was suitable, didn’t make it appropriate or in the client’s best interest.

Brokers work for broker-dealers, whose interests they serve. In other words, the brokers are employees of the firm they work for and the employer sets the tone of what’s expected.

But what about the fiduciary standard. The title sounds a lot like its distant cousin, the suitability standard, but the fiduciary standard carries more responsibility and many more regulatory requirements.

 

Investment advisers, like Alhambra Investments, are regulated by the Securities and Exchange Commission (SEC) which holds advisers to a fiduciary standard requiring the client’s interests be put above the interests of the adviser always, every time, in every way, amen.

 

Advisers (Fiduciaries):

  • Cannot buy securities for their accounts before buying them for clients
  • Cannot make trades that create higher fees for themselves
  • Must make sure the investment advice they provide is made using accurate and complete information and that the analysis is as thorough as possible
  • Must avoid all possible conflicts of interest
  • Must disclose any potential conflicts of interest

 

To break it down into a sentence:

 

The suitability standard is defined as giving recommendations that are “suitable” for the client.

The fiduciary standard is defined as giving recommendations that are in the client’s best interest.

 

Be an informed client/investor. Ask lots of questions to find out which standard the investment person you’re considering uses to make decisions for you. And then make sure that it’s a standard that best suits you and what you are trying to achieve.

Suitability standard and fiduciary standard. Similar names. Different definitions. Different outcomes.

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