Upon your research in finding an investment advisor, you may meet two terms that seem similar in a glance: fiduciary and suitability. Before investing your money, understand the differences between advisors who are held to a fiduciary standard and advisors who are held to a suitability standard.
What is fiduciary?
Investopedia simply put fiduciary standards as the standards that control investment advisers. Regulated by the Securities and Exchange Commission (SEC), the Investment Advisers Act of 1940 defines investment advisers as someone who works directly for clients and must place their clients ahead of their own.
The law controls investment advisers’ duty and loyalty care. Therefore, the law does not allow advisers from buying securities for their own before they buy their clients’. It also strongly prohibits advisers from making trades that may benefit them or their firm higher commissions. Investment advisers also need to make sure to give a thorough and accurately analyzed information as to their investment advice. The act requires them to disclose any conflict or potential conflict of interest to their clients. Advisors who fail to follow the fiduciary standards can constitute a breach of fiduciary duty and may be sued by their clients for damages.
How is fiduciary and suitability different?
Suitability, on the other hand, regulates what we know as “broker-dealers”. Investopedia loosely defines the “suitability obligation” as making recommendations that suit the best interests of their client. Suitability also prohibits brokers from racking up unnecessary trading fees and giving excessive transactions, referred to as “churning”.
The broker-dealer’s main part is to facilitate their clients with securities trades, as defined by The Balance. The broker-dealers handle their clients’ transaction process in buying or selling investment they desire. Broker-dealers’ income mainly comes from commissions they get through making transactions for the underlying customer
The SEC classifies broker-dealers as financial intermediaries, as their main objective is to help investors connect to their individual investments. Broker-dealers link the capital with a wide range of investment products from common stocks, mutual funds, and other more complex vehicles such as variable annuities, futures, and options. This role makes broker-dealers the key-role in market liquidity and efficiency enhancement. A dealer is also allowed to sell a bond out of his or her firm’s inventory of fixed-income securities.
