What Does it Mean to be a Fiduciary?

What does it mean to be a fiduciary?   Registered Investment Advisors (RIA) are required to follow the standard of fiduciary duty when working with clients, which is a legal standard that stockbrokers and other agents of broker/dealers are not required to follow. The fiduciary standard was established as a result of the Investment Advisors Act of 1940. A fiduciary duty quite simply means that an Advisor needs to do what is in the best interests of the client, and to adhere to a duty of care and loyalty to the client. The difference is that a stockbroker only needs to adhere to a suitability standard when recommending products to a client, which means that when they recommend a product or investment strategy, they must reasonably believe that any recommendations made are suitable for clients, in terms of the client’s financial needs, objectives and unique circumstances. The stockbroker has no duty of loyalty, in fact their loyalty is to their firm, not the client.56529498

To demonstrate the difference, let’s examine the case of Lisa Investor, a 45 year old single, professional whose main objective is saving for retirement.  She has a $500,000 IRA that she would like to double by the time she is 55, which means she would need a return of 7-8% on average over the next 10 years. The stockbroker could recommend a portfolio of growth mutual funds with a 5% front load ($25,000 fee) and a 1% ongoing fund management expense, and they would be following the suitability standard because the recommended funds are suitable for the client’s objectives. Many stockbrokers are influenced by expectations to place their own firm’s products or to only recommend a select set of mutual funds because they benefit their firm’s bottom line. The RIA on the other hand, may select a similar portfolio of mutual funds, but the RIA acting in the best interests of the client, would analyze the funds and would likely select a no-load, low cost set of funds. Most RIA’s are product agnostic, meaning they don’t have any reason to recommend one type of investment over another aside from the one that is most beneficial for the client. Many reps who work for large financial services broker/dealers will say that they follow a fiduciary standard, and some do, but the difference is what they’re legally required to adhere to. Stockbrokers follow a suitability standard, whereas RIA’s follow the fiduciary standard.

If you’re not careful, the suitability standard could also wind up hitting you in the pocket book.

Consider again Lisa Investor above. Let’s look at our scenarios.


The difference is significant. If Lisa works with a Rep who follows the suitability standard, she may wind up hitting her goal, but amassing $50,000 less in her portfolio due to losing a chunk of her portfolio at the onset due to the front-end load, and then paying ongoing mutual fund expenses that work to tamp down her return.

I’m an advocate for the fiduciary standard practiced by Independent RIA’s like myself. I’m partial because I think it’s the best way to help people manage their wealth. When you get on the side of your client, the relationship flourishes. That’s not to say that the suitability standard practiced by reps at brokers/dealers is bad. Most reps at broker/dealers want to keep their clients happy in order to maintain them as clients for a long time. Happy clients are key to any financial professional’s success.   That said, investors should ask prospective Advisors what standard they must follow, how they’re compensated and are they paid more for some investments than others. The answers to those questions can help an investor begin to understand what to expect during the relationship.