Standards Matter

Fiduciary Standard vs. Suitability Standard Explained:

In the financial world advisers operate under two very different legal standards:  The fiduciary standard and/or the suitability standard.

Under a fiduciary standard, the adviser is held to the highest legal code of conduct when it comes to you and your money.  They must put your interests above their own and do the best thing for you.  Registered Investment Advisers (RIA’s) are bound by this rule.

Most advisers, brokers and insurance agents (about 80% of financial professionals out there) are held to a lower legal threshold called a “suitability standard”.  This means that the type of investment they sell you must be appropriate for your situation but not necessarily the “best” thing thing for you.

Given the two choices I’m not sure why anyone would settle for “suitable” over “fiduciary” unless they just didn’t know that the different standards existed or if they didn’t understand the implications.

So how do you know if your adviser is a fiduciary?  Ask them:  “Are you acting as a fiduciary at all times and with all products when you are dealing with me?”  Have them show you where it says that they are a fiduciary in their new account agreements or disclosure documents and make sure you do not mistake a “fiduciary warranty” with a general fiduciary standard.  They are not the same thing.

Real-Life Example Illustrating The Difference:

My best real-life example of the difference between the fiduciary standard and the suitability standard comes to us from the world of college planning.  In my home state of Maryland, I often see people who live in our state but invest in the Virginia CollegeAmerica 529 Plan, not the Maryland 529 College Investment Plan.

Here is a quick comparison of the two plans:

Investments:  Both States college plans have equally good investment options.  Maryland uses T. Rowe Price mutual funds and Virginia uses American funds.

Cost:  Maryland’s plan costs less than Virginia’s.  Maryland’s total asset-based costs range from 0.07% to 0.88% a year.  Virginia’s cost is higher at 0.45% to as much as 2.29% annually.  All other things being equal, I always favor the less expensive investment option.

Tax benefits:  If you live in Maryland and make contributions to the Maryland 529 plan you get a State tax deduction of $2,500 per year per account beneficiary.  If you live in Maryland and instead decide to contribute to the Virginia 529 Plan you get no State tax deduction.  For a Maryland resident it makes no sense from a tax-planning perspective to invest in the Virginia 529 plan.

Broker Compensation:  The Maryland plan is sold directly to the consumer so there is no broker or middle man that needs to be paid.  The Virginia CollegeAmerica plan is broker sold so part of the higher cost goes to pay that middle man.  This is the real reason Maryland residents end up in the Virginia plan.

Implications:

For a Maryland resident it is clearly not worth paying more for the Virginia CollegeAmerica Plan and giving up  the Maryland State tax deduction in the process.  But a broker can make the case that any college savings account is “suitable” for you.  It just might not be the “best” option available.

Standards really do matter.