Two types of financial advisors

Imagine having a friend or neighbor that you could turn to whenever you had a financial question. Think about how amazing that would be. Not sure how much of a house you can afford? Call your financial friend to walk you through the numbers. Don’t know which mutual funds to choose in your 401(k)? No problem, you have someone to answer that question.

All of us make financial decisions every week. Most often, we do it alone without help. How comforting it would be to pick up the phone, ask that question, and get an answer that is not only correct, but in your best interest.

Unfortunately, we don’t have this in the United States. The current regulation structure allows financial advisors to fall into two different categories. They can follow a “fiduciary standard” or a “suitability standard”.

The fiduciary standard simply means that an advisor must provide recommendations that are in the clients’ best interest. Even though the TV commercials paint a different picture of trust, a majority of financial advisors are not required to put their clients’ best interests first. They operate under the suitability standard.

Right now, there is a looming financial crisis of Americans not saving enough for retirement. People have been taught very little about personal finance. If they reach out to a financial advisor that falls under the suitability standard, they are likely to be sold expensive products not in their best interest.

Let’s say an advisor can recommend one of two mutual funds. The first fund has low costs and good performance. The second fund has high costs and poor performance, but pays a commission. The advisor under the suitability standard recommends the expensive, poor performing fund because that is how he will get paid. It’s not in the client’s best interest, but it is “suitable”.

The large financial firms argue that a fiduciary standard would hurt low-income and middle-income investors. Advisors wouldn’t be able to sell them products. And these folks wouldn’t be able to afford fiduciary financial advice. In short, they would lose access.

This is a ridiculous argument. One of the products financial advisors sell is variable annuities. These expensive financial products have commissions of 7 to 10 percent. Last year, more than $200 billion of variable annuities were sold in the U.S. That means investors paid somewhere in the range of $14 billion to $20 billion dollars in commissions to financial firms and their advisors. With those high costs, it’s not fiduciary advice Americans can’t afford.

Four years ago, Congress ordered the Securities and Exchange Commission (SEC) to study the impact of applying the fiduciary standard for all financial advisors. The SEC finally announced this year that the fiduciary standard is on its agenda as a “long-term action”. That means it could take another three to four years before the SEC makes any recommendations.

Until the SEC acts, it’s important to know there are two types of financial advisors. Be sure to ask if your financial advisor operates under the fiduciary standard or the suitability standard. It’s in your best interest.

Steve Doster is a Certified Financial Planner™ professional providing commission-free financial advice for do-it-yourself investors. You can reach Steve at Doster Financial Planning by phone 619-688-1192 or email steve@dosterfinancialplanning.com. You can also follow Steve on Facebook, Linked In, Twitter, or blog to get more personal finance advice and tips.