You may not know this, but investment advisors and financial advisors are held to different standards of accountability when it comes to the investments they make on behalf of clients. Investment advisors have long been held to what is called the "fiduciary standard." This standard means, in effect, that investment advisors must always and at all times act in the best interest of their client, even when that interest runs against their own best interest. In other words, investment advisors must, as a matter of law, strictly serve the best interests of their clients.
The Dirty "Open" Secret of Stock Brokers
Unlike investment advisors, stock brokers have customarily been held to the "best interest" standard. This standard operates in the negative. It insists that brokers may not put their own best interest above their clients.
How about that for some conceptual gymnastics? Let's see how that works, and how it's different from the fiduciary standard.
The Fiduciary Standard vs The Best Interest Standard
If you haven't already surmised it, the Fiduciary Standard asks more of financial professionals than does the Best Interest Standard. It is a more rigorous, demanding, and self-sacrificing rule of conduct that, in practice, when things go wrong, is actually much easier to enforce and rectify.
As an example, let's say that you're an investor, and you approach two different financial professionals about investing some of your money. You tell them all about yourself - creating your investor profile - and you show them your financials. Now, the financials professionals must recommend both an investment strategy and individual investment products to you. That's why you hired them of course!
So both of these men or women look around and they see almost limitless options for investment. Some of them will be suitable for you, and some won't. "Suitable" means, to put it simply, they harmonize with your risk-tolerance, investment objectives, and investor profile. So that part is the same whether you're working with an IA or an FA. Now let's say the financial professionals find several products which might be suitable for you, which is almost always the case. Now the question becomes, for the broker or IA, what about me? What do I stand to gain from this transaction?
Two Investments, Two Standards of Investment Professional Conduct
Here's where things get interesting. Let's say, all things being equal, the investment advisor and the financial advisor find two products that offer them different levels of compensation, one higher and one lower. Which should he or she choose?
Now let's go back to the standards. The Fiduciary Standard says: the advisor MUST choose the option that is best for the client, regardless of what is best for the advisor. The Best Interest or Suitability Standards is less rigorous: it says, "Well, as long as the advisor does not put his or her interest AHEAD of the investor's, we're ok with that."
See the difference?
The Best Interest standard opens the door for stock brokers to weigh their own interest more heavily, even up to and including almost exactly equal weight to their client's interest. The Fiduciary Standard, on the other hand, is firm: the clients interest must outweigh the advisor's interest.
So what do you think? Do you think the Best Interest Rule is in your best Interest? Or do you think, when it's your money at stake, and you're paying the advisor for his or her time and expertise, that your interest should be the primary and decisive one...? Yeah, we thought you'd say that.