Here’s the quick-and-dirty guide to who lives by which standard: Someone who sells advice is, in all likelihood, a fiduciary, while someone selling investment products is not.
You may have a tough time telling the difference. A lot of consumers think they are being sold advice, when they are being pitched products. The financial services industry has created that situation, largely because so many people did not want to act as fiduciaries and do what was best for the customer if it meant doing something that was not ideal for the service provider.
The fact that customers don’t necessarily know the difference between the two standards is one thing.
Requiring a fiduciary standard for everyone is something altogether different, because the goal would be to eliminate the confusion and give the customer the standard of care he or she currently expects, even if it’s not what he or she is getting under the letter of the law.
Someone who sells advice is, in all likelihood, a fiduciary, while someone selling investment products is not.
Requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient. They would have to disclose potential conflicts of interest, such as any fees or payments received for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere.
For example, a broker couldn’t put you in a mutual fund with higher fees — or one he gets a bigger commission for selling — if he could get a comparable fund with lower fees elsewhere.
Financial services pros say that the difference between the suitability standard and a fiduciary responsibility is semantics. They couldn’t be more wrong, because once you put those words into actions, the costs can add up in a big, fat hurry.
For proof, here’s an example using easy, round numbers:
Say you are 35, plan to retire at age 65 and have $10,000 a year to save for retirement. Your broker has a plan for netting a 6 percent return annualized over the next three decades. It will turn your money into an $800,000 nest egg when you plan to call it quits. Not bad.
What you’re not necessarily aware of is that the broker earned a big fat commission for selling you on the plan, and that the higher expenses charged by his financial firm — which runs the funds you bought — also took a cut off the top.
Had the broker directed you into a portfolio of low-cost mutual funds, your same money might have netted an 8 percent return. Over 30 years, that would have left you with a retirement war chest of $1.1 million.
The high-cost, high-commission investment might qualify as “suitable,” because it meets your need to amass a retirement nest egg. Despite leaving you dramatically poorer, it passes the regulatory sniff test.
Meanwhile, had the advisor put your best interests first, you would have paid less commission and purchased the lower-cost fund, and you might be $300,000 richer for it.
While situations can be drawn up to show nearly any possible outcome, better or worse than this one, the key to remember is that the dollars at stake between “appropriate” and “best” are very real. And they’re yours.
For years, investment advisors have been held by regulators to a fiduciary standard. Brokers, however, were excluded from the definition of “investment advisors,” so long as they didn’t get paid special compensation for their advice. If the advice was “solely incidental” to their brokerage services, they merely had to uphold the suitability standard.
Over time, however, many brokers held themselves out as financial planners but lived by the more lenient standards. Some brokers also became registered both ways, operating under the suitability standard when they sell product, but operating as a fiduciary when they sell their advice. Ultimately, the SEC held that an advisor can play both roles.