In the healthcare industry, you have one standard- the American Medical Association’s Code of Ethics. There is a clear line of relationships and responsibilities of medical care professionals to their patients.
However, in the financial services industry, there are two different standards. Often those standards can be applied to the same job titles within the industry. This makes it difficult for you to understand what type of relationship you are signing up for.
The first is the fiduciary standard, which requires that an advisor must put their clients’ interests above their own. They must follow the very best course of action, regardless of how it affects them personally or their income.
A fiduciary’s advice must be the result of a thorough and accurate analysis. They must follow-through in the most cost-effective manner possible. It is also essential for fiduciaries to avoid conflicts of interest, so any potential conflicts must be clearly disclosed.
The other standard is called the suitability rule. This standard was updated in 2020, requiring investment dealers to follow what is known as a new “best interest” standard. The term "best interest" standard can be misleading and cause confusion. While the suitability rule standard has tightened and has a new name, it does not protect investors as well as the fiduciary standard.
Advisors simply must give advice that is suitable for a client based on their financial needs and specific circumstances. If their advice is not clearly bad, they are not required to give the best advice. They can recommend investments that put more money in their pockets with commissions, as long as they meet certain disclosure requirements.
In a 2016 Forbes article, this story summed up the difference between the two standards if it were applied to car salespeople:
Fiduciary vs. Suitability: What’s The Difference?
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 listing features and attributes that are best described as 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 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.
Under the fiduciary standard, the dealer would be obligated to say, “It sounds like you are describing a Toyota Highlander. We don’t sell those. In order to get exactly what you described, 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, it’s more expensive and it isn’t exactly what you described.” In this scenario, you have more information about your options and the conflicts motivating the dealer.
The Ford dealer has a clear conflict of interest in this situation. He can only sell Fords and will lose the opportunity to earn a commission if the client buys a Toyota Highlander. Under the suitability standard, the client ends up with a product (Ford Explorer) that isn’t the best fit given their situation and it costs more than the better-fitting product (Toyota Highlander). Worst of all, the client probably has no idea that they weren’t given advice that put their own interests first.1
Registered Investment Advisors vs. Broker-Dealers
Registered Investment Advisors (RIAs) are legally required to follow the fiduciary standard. All advisors employed by RIAs must always put their clients first, and their loyalty is to the client above all else.
Broker-dealers and investment dealers follow the suitability or best interest rule. Even if they call themselves financial advisors, their brokers do not have to put client interests above their own. Their loyalty is to their paycheck.
What Standard Does Your Advisor Use?
If you don’t know which standard your advisor adheres to, the best way to find out is to ask. A fiduciary will not hesitate to put it in writing. If your advisor is not open about it or follows the suitability rule, you may want to interview other advisors.
If you are looking for a fiduciary investment advisor, we look forward to hearing from you. You can reach us at (812) 421-3211 or email us at email@example.com. Donaldson Capital Management is a fiduciary. Our investment advisors will put your needs first and always act in your best interest.
This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.
S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.