Fiduciary Duty vs. Suitability: Understanding Your Financial Advisor's Obligations

It’s a sad fact, but brokers don’t always act in your best interest. And there is nothing that requires them to. It may be hard to believe but brokers, investment specialists, insurance agents, some financial advisors, and other professionals that you trust with your money aren’t always required to act in your best interests. They do not have what is referred to as a fiduciary duty.

Suitable vs. fiduciary standard. Brokers are required to recommend “acceptable” or “suitable” investments, but “suitable” doesn’t mean the best performing stock or investment, just that it is an appropriate investment. As a result, some brokers recommend investments with higher commissions. Registered investment advisors, however, are required to follow a fiduciary standard, which means they must put your interests before their interests. An example would be choosing the fund with a lower expense ratio.

Should Investment Professionals Be Required by Baw to Act in Your Best Interests?

There are many people calling for a change in the financial and insurance industries to require professionals to act in the best interests of their clients at all times. Unfortunately, there is no current requirement.

I have had two bad experiences with financial advisors – once with an independent broker and once with a broker who worked for a well-known investment firm.

These two bad experiences changed the way I act toward investing by forcing me to earn more and become more hands-on with my approach to investing.

Financial Planners Do Not Always Act in Your Best Interest

I will start this by stating there are some great financial planners out there. But there are also those who pay more attention to their interests than yours. And you know what? There aren’t always laws that require them to act in your best interest.

Let me give you two personal examples of times when brokers acted in their interest when advising me on investments.

Example 1: Advisor Recommends High Commission Funds

When I joined the military in 1999 and had my first steady paycheck, I knew I wanted to invest. I just didn’t know anything about it.

I had heard of an IRA, mutual funds, front loads, back loads, etc., but that was the extent of my knowledge. I still wasn’t really aware of much more about the IRA, such as the Roth IRA contribution limits.

I opened an IRA at age 19. I didn’t know anything about stocks, bonds, or mutual funds, so I placed the money into a Money Market Account where I probably earned an astounding 3.0% return on my money.

I talked with some of my friends and coworkers; however, few were investing at the time. This was also before the military had the TSP (Thrift Savings Plan, Government version of a 401k) as an option.

I went to a financial planner my friend recommended, and the advisor had me fill out a questionnaire that included my income, what I wanted to save for, future goals, etc. So far so good. In fact, he was very nice and helpful. When we went over my list, he recommended I open a Roth IRA, and he helped me fill out the paperwork to convert my Traditional IRA to a Roth IRA to the fund I was purchasing through him. (I didn’t have any tax implications because I hadn’t yet filed taxes for that year, and my income was below the Roth IRA limit.)

What Seems to be the Problem?

Well, I signed up for a mutual fund through him, which was a large-cap fund through a major investment firm (I believe it was Fidelity, but I may be mistaken, as this was almost two decades ago). I had heard of Fidelity and knew of their great reputation, so that was cool. I also knew fees would be involved because you can’t invest entirely for free. Not even through index funds.

What I didn’t know was how expensive investing could be. I paid a $1,000 front load to agree to a 15-year investment plan to purchase the Fidelity fund (I could get out of the plan at any time without any fees, but the $1,000 was non-refundable). He sold me on the idea of a front load by telling me to think about the $1,000 being extended over 15 years, so it was not a big deal.

Then I Did Some More Research

Then I began to learn a little more about investing, how the stock market works, etc. I read about stock classes and index funds, and I realized the mutual fund the broker sold me, a large cap fund, mimicked the S&P 500 very closely. Too closely in fact. I realized that over the previous ten years, the trends were almost identical.

After doing more research, I determined the holdings were almost identical and I was paying 1.60% for a managed fund that was doing no better or worse than the S&P 500 – the same fund I could get for less than 0.20% in fees. So I transferred the entire fund to Vanguard’s S&P 500 Index fund where I paid 0.18% annual fees (the fund is currently at 0.14%). That’s less than 1/10th the fees for similar performance – and no load!

Don’ forget, I paid a $1,000 front load for the fund. That was when I realized brokers do not always act in your best interest.

It wasn’t until I learned much more about investing that I learned I was taken advantage of. I didn’t pay that $1,000 to Fidelity; I paid it to him. I also still had to pay the normal fees to Fidelity for the managed fund.

That was an expensive lesson that cost me a lot of money. Thankfully, I caught on before I caused myself too much long term damage.

Cutting My Losses

I thought long and hard about the situation, and I finally decided the best action was to roll my IRA out of the investment I was in. Though I was originally told the $1,000 was to be spread out over the course of my investment plan, the $1,000 was really an upfront fee to the broker. That $1,000 was a sunk cost. It was gone forever, whether I continued investing in his fund, or if I moved the money elsewhere.

Losing $1,000 hurt. But when I analyzed the numbers, I realized that paying lower fees would allow me to keep more of my money working for me and compounding for a long period of time.

In the end, the numbers don’t lie – having the lower fees would give me a better long term return. I counted the $1,000 as a sunk cost and vowed to do better research before ever investing again.

In the end, I am not mad at my mistake of “losing” $1,000. I got into the habit of automatic investing, which is something I continue to do and will continue to do in the future.

More importantly, I learned that I need to educate myself and learn how to make my own investment decisions. This is a large reason why I started this personal finance blog – to learn and share information about personal finance. If one person reads this and doesn’t make the mistake I made, then I’ve accomplished something good.

Example 2: Advisor Expected me to Blindly Follow Advice

A few years after I moved my IRA to Vanguard, I decided I wanted to invest more money. This was in 2005, so it wasn’t very long ago. I had done some research and reading, was maxing out my Roth IRA and had started a small allotment into the TSP. I went into a well known and respected brokerage firm (I will abstain from naming the firm because I believe my experience may be isolated to this particular broker, and I do not want to influence anyone’s decision to invest with this firm).

I set up a meeting with the broker and went over some of the same things as before – my earnings, current investments, future goals, etc. I told him I was maxing out my Roth IRA, investing in a tax-deferred retirement plan, looking to diversify into a non-retirement investment, and I was seeking advice. (At this point I had progressed beyond just an S&P 500 index fund, but I still love index funds and their LOW fees!)

He didn’t give me time to research the fund, think about how it met my goals, etc. It was a ‘one size fits all’ approach. No thanks!

I told him I would think about it and stood to leave. He handed me a stack of his business cards and asked me to hand them out to friends on base. (I’m sure he saw $$$$ signs everywhere!) Nope! I threw those cards in the trash as soon as I left!

I later looked up the fund and it had a 2.1% fee! That’s insane! Especially since it was basically a large-cap index fund! I’m sure it also came equipped with a fat commission.

What I Learned from These Experiences

A lot. I learned how to invest for myself. I researched investing. I read books, magazine articles, websites, etc. I talked to people with experience. But most importantly, I kept investing and continue to invest today.

With everything I learned, I steered many junior enlisted military members and good friends toward investing. I always made it a point to give them information and resources; I never told them how or where to invest their money. Many of them have thanked me for getting them started.

Yeah, it sucks that I gave away $1,000 for a BS load fee. In the end, I think it drove me to learn more about how investing works and how I need to do more learning and researching before jumping in. And if one person reads this post and doesn’t make the same mistakes I made, then I guess I’ve done some good 🙂

Be sure to research your brokers. Know your personal investment plan. And most importantly, understand how your investments work!

How to Find the Right Investment Advisor

I highly recommend interviewing several investment advisors before hiring one. You want to understand how they work, how they are compensated, whether they have any requirements to put your interests first, and much more.

You may also wish to perform a background check on your advisor.

Most importantly, you want to be able to trust your advisor. I knew I wouldn’t be able to trust the two salesmen I had experiences with. They weren’t advising me. They were steering me toward funds that benefited them more than me.

No One Cares About Your Money As Much As You Do

There is a market for financial planners. And they do provide a needed service. But I encourage you to understand how they are compensated and learn as much about the process as possible before hiring one. There are many great financial advisors who will take care of you and act in your best interests.

However, there are are also many advisors out there who will steer you toward products and services that give them the biggest commissions.

Reader question: Should all financial brokers, advisors, insurance agents and others be required by law to follow a fiduciary standard of care – that is to say, put the interests of their clients ahead of their own interests?