The Confused Investor
My wife was planning on taking me shopping for kitchen cabinets this coming weekend, so I set off to learn as much as I could about doors, concealed hinges, silent closing drawers and any other beveled-faced terminology I could find and “all of which I could do without” before the main event. I was preparing to do battle on cabinetry lexicon and knowledge with a salesperson, who I believed would invariable seek to maximize a sale, not necessarily offering me the best deal for what I needed. Fortunately for me, it didn’t take too long to figure out and select the cabinets.
Reflecting upon this experience, I wondered about something much more close to home for me. After reading the latest comments from the Department of Labor Secretary on expanding the definitions of fiduciary to more financial advisers of 401(k) ad individual retirement accounts, and comments from the Financial Services Institute, which represents independent broker-dealers and financial advisers who oppose this initiative, I wondered how a lay person would go about trying to understand the financial landscape in which they would have to maneuver for the right financial advice.
My suspicion was that most investors, including so-called smart investors, probably couldn’t discern between suitability and fiduciary standards. I therefore conducted an informal survey of about 25 hedge funds and investment professionals in my personal circle. The result was no surprising “only 6 knew the difference and were able to give me an example of how it applies to the financial services industry. It’s no wonder Fidelity, Merrill, and other brand-name financial institutions don’t build their marketing campaigns around suitability and fiduciary standards.
So here is what you would need to know if you are seeking financial advice and want to know how these two standards will impact you directly. Although suitability standards are good, it could be better, as a broker has no explicit duty to act in your best interest, but merely to advise you on investments that are suitable, regardless of whether a better or more cost-effective alternative is available. Fiduciary on the other hand, is like suitability on steroids. It mandates that an advisor act in your best interest. So in this example, the advisor would have had to not only recommend a security that’s suitable, but also one that is in his or her judgement, perform better or be more cost-effective.
If this is still too confusing, look for financial advice from professionals who are registered investment advisors (RIA) or one that is an affiliate of one. They are bound by the mandates set forth in the Investment Advisor Act of 1940, which holds advisors to a standard that requires them to put your interest above their own. Their duty is to their broker-dealer, not necessarily to you. Often a simple way to identify a broker-dealer is to see if they have a disclosure statement on their business card. It would read: all securities offered through, at which point, you should know to pay attention to what they are recommending and then get a second opinion.
Titles can clearly be misleading sometimes so really pay attention to the disclosure. My kitchen cabinet salesperson’s business card read: kitchen consultant, yet, this absolutely did not make him my fiduciary.
Needless to say, my weekend outing with my wife was an adventure and preparation probably saved me some amount of dough. The preparation I believe all investors need to do for a sound and better financial future is a far greater endeavor that should be thoughtfully considered, as it’s one that can pay off many times over.