Why should you care that a financial professional follows a fiduciary duty instead of what's suitable for your portfolio?
At first glance, the idea that someone like a wealth manager, broker or financial advisor touts an investment that's suitable for your goals seems perfectly fine. After all, it seems in line with your risk tolerance and what's more, that professional might be talking about the high standard they're held to through the Financial Industry Regulatory Authority, also known as FINRA.
However, pay careful attention to the word "suitable."
Several investments may be "suitable" for your portfolio. Only one of them can be the very best. Now, we obviously can't foretell the future about what will be the best investment outcome, but we can recommend what we believe to be the best option. At least, that's what a genuine fiduciary can do and further, is legally obligated to do.
Here's an easy example of what we mean:
You're sitting down to dinner at a nice restaurant, where you're presented with a variety of interesting menu choices – so many that you don't know which one to order. You're kind of thinking that you want a steak but the lobster tail looks nice too. You ask the waiter his opinion on which he likes better.
He surprises you by saying, "You could go for one of those two, but how hungry are you? We actually happen to be running a special of Surf-And-Turf that gives you a taste of both for only a few dollars more than each individually." Now, the restaurant may make a little more off of your plate, but the real incentive in the waiter's recommendation is giving you the very best experience for the money because you liked both options. He's pointing you toward the very best option considering your goals. In fact, if he didn't have what you were looking for on the menu, he'd be so honest with you that he'd point you toward a great restaurant down the street that had more of what you were looking for.
Now let's imagine if a different waiter took your order at the same restaurant. He recommends a seafood platter that's not bad and tastes fine enough – it's just not the best for what you were really craving. But your waiter doesn't care. Because what you don't know is that he's been incentivized by management to sell more of that platter tonight than anything else on the menu. He's all about the sale.
The first example resembles what a relationship can be with a professional who must follow their fiduciary duty and recommend the best option to an investor. All information about any product has to be disclosed upfront and transparent. A fiduciary is not paid on commission, so there is no extra incentive for recommending one asset or another.
The second scenario resembles more of what a broker relationship looks like – a professional who is held to a "suitability" standard but not a fiduciary duty. Such individuals are not fiduciaries and therefore are not obligated to put their clients' best interests first. They can point you toward an investment that may technically be a suitable fit and pays them a handsome commission in the process. But is it the ideal option for you? Not necessarily.
Remember, only a fiduciary can:
- Be required to register with the Securities and Exchange Commission (SEC) or a state securities agency
- Be legally bound to act solely in your best interest
- Provide complete financial advice by recommending one investment over another
- Select and manage investments for you
- Recommend investments without being paid on commission