In the medical profession, physicians practice according to a familiar standard: “First do no harm.” There should be a similar level of commitment for anyone who wants to advise you about your financial well-being, right? Unfortunately, wrong. Financial advice is subject to a double legal standard: “fiduciary” versus “suitable”advice. Worse, it’s up to you to spot the differences between them, and to heed the quality of the advice accordingly.
Fiduciary vs. Suitable: What’s the Difference?
Why the different legal standards? Government regulators assume that a broker’s primary role is to place trades, so any advice he or she offers is considered secondary to this main, transactional business. A broker’s advice must be suitable for you, but it does not have to be best for you.
In addition, a broker does not have to reveal if a conflicting incentive is driving the recommendation. In his Washington Post column, “Find a financial advisor who will put your interests first,” Barry Ritholtz describes suitable advice in blunt terms: “The suitability standard is far more complicated – and offers much less protection to investors. The simplest way to describe this standard is ‘Don’t sell AliBaba IPO to Grandma.’”
Let’s provide an example of how suitable and fiduciary advice can differ from one another. Imagine you are comparing two mutual funds that are equally appropriate for your portfolio, except one entails higher fees that just happen to offer a bigger commission to the trader. Brokers offering suitable advice can freely recommend funds that compensate them more handsomely at your expense … without disclosing this fact to you.
On the other hand, if all else is equal between two investment selections, a fiduciary advisor must recommend the lower-cost investment that represents your best interest. As a fee-only firm, we do not accept third-party commissions or any other sales incentives to begin with, but even were we to do so, we would still be obligated to place your interests ahead of our own and recommend the lower-cost solution. It would be illegal for us to do otherwise.
Suitable Illustrations in Action (or Inaction)
You may wonder whether suitable conflicts of interest really matter. If you’re working with a financial pro and your investments seem to be doing okay, is there any harm done if he or she receives a few extra dollars along the way?
We believe that the investment damage done can be considerably more significant than most people realize. Take this illustration of a couple in their 70s, the Toffels, who were featured in aNew York Times exposé, “Before the Advice, Check Out the Adviser.”
The Toffels were not sold an AliBaba IPO for their $650,000 life savings, but their broker did saddle them with a variable annuity that cost more than 4 percent annually. “That’s more than $26,000, annually – enough to buy a new Honda sedan every year,” observed the columnist. The annuity also included a 7 percent surrender charge, effectively trapping the Toffels in the overpriced holding. Consider this in the context of a typical, no-frills index fund costing less than 0.25 percent, with no surrender charge.
The article points out: “Like many consumers, [the Toffels] say they didn’t realize that their broker wasn’t required to follow the most stringent requirement for financial professionals, known as the fiduciary standard.”
Not yet convinced? Consider a January 2015 internal memo by Jason Furman, chairman of President Obama’s Council of Economic Advisers. In it, he estimated that as much as $6–$8 billion per year is being lost to conflicted advice that may “encourage savers to move from low-cost employer plans to often higher fee IRA accounts, and from incentives to steer savers into higher cost products within the IRA market.”
Granted, Furman’s estimate may itself be influenced by the political backdrop. But combine this with The New York Times piece (and many other examples we could cite), and the illustrations draw a clear conclusion: Suitable “advice” costs plenty of families plenty of wealth that would otherwise be theirs to keep.
Fiduciary vs. Suitable: How Do You Know?
We believe investors deserve better than advice that is merely suitable for their life’s savings. That’s why we established Dowling & Yahnke as a fee-only Registered Investment Advisor firm, which commits us to always and exclusively be fiduciary advisors to our clients. By law and design, we are dedicated to placing our clients’ financial well-being at the very top of our decision-making criteria, even ahead of our own business interests.
Unfortunately, unlike in the food industry where it’s easy to differentiate a vendor from a healthcare professional, it’s often unclear in the financial world just who you’re dealing with, where their interests lie and what kind of advice you’re receiving. In our next article, we’ll offer some pointers on how to ensure your advisor is a fiduciary, always looking out for your best interests.