March 11, 2021 | Reading Time: 4.0 min
The Importance of Working with the Right Financial Advisor
In the financial industry, advisors can be licensed in multiple ways and thus have different standards of care they are legally held to when working with clients. The first is the suitability standard of care and the second is the fiduciary standard of care. You may have heard these terms before; the meaning of these terms are often misunderstood and misused, so let’s look at exactly what each term means.
According to FINRA rule 2111, the broker-dealer is held to a suitability standard of care, requiring them to have a reasonable basis to believe that their recommended investment strategy is indeed suitable for the customer. There must be an investment rationale for each product or investment recommended. This includes the expectation that the broker-dealer will know the customer and their financial situation thoroughly. The suitability standard mostly applies to product sales and financial transactions.
The fiduciary standard of care requires that a financial advisor act solely in the client’s best interest when offering personalized financial advice. This means the advisor is required to act in the client’s best interest, specifically to always put the client’s best interest in front of their own. This standard includes a duty of loyalty to the client, full disclosure of any unavoidable conflicts of interest, as well as full and fair disclosure of all material facts. The fiduciary standard mostly applies to the delivery of financial advice.
So how do you know what standard your advisor is operating under?
It comes down to what type of firm the advisor works for and how they are licensed. There are three general categories; here’s a basic breakdown:
1. Brokerage firms are held to a suitability standard of care. Their chief business is executing transactions on their clients’ behalf, and are therefore largely considered sales representatives. This category includes all the major, well-known brokerage houses and most investment banks, as well as smaller regional broker/dealers. Brokerage firms are all regulated by the Financial Industry Regulatory Authority (FINRA).
2. Insurance companies are regulated by individual states, and standard of care varies among them. This includes major national insurance companies and smaller regional companies alike. The standard of care for advisors selling insurance closely parallels the suitability standard of care.
3. Registered Investment Advisory firms (RIA’s) are held to a fiduciary standard of care. RIA’s are in the business of providing financial advice, as opposed to transacting on their clients’ behalf. While all the major national firms we tend to think of when we hear “investment company” are brokerage houses, RIA firms tend to be small and regional businesses. RIA’s are regulated by the SEC (Securities & Exchange Commission) if they manage over $100 million, and by their home state if they manage less.
Think of it like this: you wouldn’t expect your butcher to give you well-rounded and objective dietary advice; they are solely in the business of selling meat. If you want advice about comprehensive meal planning, you go to someone who is an expert in the field of diet & nutrition, such as a nutritionist.
In similar fashion, you shouldn’t solely depend on a broker or insurance salesman for holistic financial planning. Rather, you should work with a fiduciary advisor. Essentially, anyone who is paid for giving you advice must act in your best interest at all times whereas someone selling you a product isn’t legally held to that same standard.
Ultimately, know who it is you’re talking to about your finances. Ask your advisor if they are a broker-dealer, an insurance agent, or an independent registered investment advisor. Knowing this will help you determine if you’re working with the right professional or not. That standard your advisor is held to will make a difference in your bottom line.
Who do you want to work with? You make the call.
Investment advisory services offered through Foundations Investment Advisors, a registered investment adviser ("Foundations"). The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Jay Hagy providing such comments, and should not be regarded as a description of advisory services provided by Foundations or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.