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What’s the Difference in Real Life?

Suppose you need advice on developing a sound investment portfolio. Under the fiduciary standard, an advisor is required to look for what he or she believes to be the best possible mix of investment categories—which may be mutual funds that invest in foreign and domestic stocks and bonds, and in stocks of different sizes and flavors. Then the fiduciary standard would go further, and require the advisor to research the track records, manager tenure and annual costs of different mutual funds, to identify those he or she believes will provide the best return with the least risk and expense.

If you talk with a broker, agent or someone who has a sales license, then this person would be governed by the suitability standard, which means that he or she would (once again) determine that you need mutual funds. However, the similarity stops there. Someone who provides recommendations under a suitability standard would be legally free to recommend the mutual funds that pay him or her the highest commissions, and that money has to come from somewhere, right? It comes out of your pocket in the form of high fees that the fund takes out of your investment over the course of the year. There is no suitability requirement that the funds be well managed, or that the portfolio be diversified among different asset classes—or (and this is the important point) in your best interests. Chances are the recommendation will be in the broker or agent’s best interests.

How did we get two different standards for people giving advice? Most people don’t realize that there are actually two different laws in the legal code, one governing brokers, the other governing advisors.