When you work with an investment professional such as a wealth manager or financial advisor, it’s reasonable to expect any moves being made in your accounts or strategies being suggested for your financial plan will be in your best interest, right?
Unfortunately, it’s not always that cut and dry. It’s imperative when searching for the right advisor to be aware of the are two standards of care in the financial industry: the fiduciary standard of care and the standard of suitability.
Knowing how they compare and choosing the right one for you could be the difference between reaching your goals and falling short.
As a firm that has practiced under the fiduciary standard for more than 40 years, we have a unique understanding of these standards of care and have seen first-hand how suitability and fiduciary compare (but mostly contrast).
In this article, we’ll offer an overview of each standard, touch on what these standards actually mean for the client, discuss how they are regulated, and walk through an example of how advisors might apply these standards in their planning and investment advice.
What is the Fiduciary Standard?
The fiduciary standard legally requires an advisor to put their client’s interests first, regardless of potential personal gain.
Fiduciary firms typically operate under a fee-based structure which helps support their fiduciary standard as their wallets aren’t being padded by commissions or kickbacks.
The Securities and Exchange Commission (SEC) enforces this standard for Registered Investment Advisors such as Plancorp.
Fiduciary Standard of Care vs. Suitability
The suitability standard was created by brokers (also known as registered representatives) and is enforced through self-regulatory organizations called the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA).
Suitability requires that recommendations are “suitable” based on the client’s personal situation, but the standard does not require the advice to be in the client’s best interest.
Let’s walk through an example of the suitability standard:
Imagine you need a new car, but you don’t know much about different options. You head to the closest car dealer, which happens to be a Ford dealership.
The dealer asks you to describe what kind of car you need, and you begin to list features and attributes that are best met by a Toyota Highlander.
Under the suitability standard, the dealer could say, “A Ford Explorer would meet all of your needs and we have some of those right over here.” The dealer then makes the sale and gets the commission.
You have a car that is suitable for your needs, but it isn’t necessarily what’s best for you. Since you don’t have a great deal of knowledge about the auto market, you are in the dark and led to believe the Explorer will be right for you.
Under the fiduciary standard of care, however, the dealer would be legally obligated to say, “It sounds like you are describing a Toyota Highlander. We don’t sell those. You would have to go down the street to Toyota and ask for a Highlander. I can sell you a similar model called a Ford Explorer, but it’s more expensive and it isn’t exactly what you need.”
In this analogy the Ford dealer has a clear conflict of interest. They can only sell Fords and will lose the opportunity to earn a commission if the client buys a Toyota.
Under the suitability standard, the client very likely ends up with a product that is more expensive and not the best fit for their needs. Worst of all, the client probably has no idea that they weren’t given advice that put their own interests first.
This analogy is helpful in understanding the difference between these standards, but likely doesn’t convey the full impact of what this looks like when your financial plan is on the line, not just a new car.
Getting ‘suitable’ advice can compound over time into big differences in your situation. Maybe a fund was just a bit more expensive or a bit off your preferred risk tolerance, but still ‘suitable.’ Project that out over a decade or two and you would be surprised how impactful your best fit is.
Department of Labor Rules
Rules governing retirement investment advice haven’t changed much since 1975, despite the dramatic shift away from defined benefit pension plans to consumer-controlled options such as an IRA or defined contribution plans such as a 401(k).
In recent years, however, the Department of Labor has been addressing some conflicts of interest by requiring fiduciary standard of care when advising on retirement accounts.
There has been a negative response from Wall Street and the insurance industry, but this is a huge win for individual investors.
There will still be room for improvement within the broader financial industry, but these new rules will eliminate some bad practices and make it easier for investors to make a successful legal claim against adviser malfeasance.
In April 2024, the U.S. Department of Labor released final regulations defining an investment advice fiduciary and amending several prohibited transaction class exemptions.
The new rule replaces the "five-part" test and broadens the definition of who may be considered a fiduciary under ERISA.
Now, anyone making an investment recommendation to a "retirement investor" for a fee or other compensation is considered an investment advice fiduciary.
For Plancorp clients, we don’t anticipate much change because we already act in a fiduciary capacity.
In fact, we were one of the first Registered Investment Advisors in the nation (and only firm in Missouri at that time) to earn the Investment Advisor Certification for Fiduciary Practices from the Center for Fiduciary Excellence (CEFEX) a certification we’re proud to say we have continued to earn annually for over 15 years.
Final Thoughts
Perhaps we are biased, but we believe our clients and anyone seeking to partner with a financial professional, should get the Highlander of care, not the Explorer of care. (No hate to Ford, of course.)
Working with a firm that operates under the fiduciary standard of care is the best way to ensure your best interests are being prioritized and you are only paying for the advice and service you’re receiving.
Standards of care are just one piece of a larger puzzle, though. Our free interview guide will help you know the right questions to ask when interviewing advisors and finding the best fit. Download it below to feel confident in your research and decision-making progress.
