By Graham Bodel, CFA
Special to the Financial Independence Hub
There’s a lot of furor in the US right now over the Department of Labor’s proposed legislation to make all those providing retirement advice in the US actually act in the best interest of their clients (I know, a crazy concept).
Regulators in Canada are also pondering the issue and no doubt we’ll eventually see some change here too. But interestingly most investors have no clue that there are two different standards (fiduciary vs suitability).
You’d think people would without question want to work with someone with their best interests at heart. There are relatively few who give advice in the investment industry either side of the border who are currently required by law to act in their clients’ best interest.
It’s not like this is a crazy idea – think doctors and lawyers – all required to act as fiduciary. Now clearly being an official “fiduciary” doesn’t mean you’re perfect and there are certainly many advisors who don’t technically have a fiduciary responsibility who still act in their clients’ best interests, but the incentives are strong and studies suggest there’s something to this.
The difference between fiduciary and suitability
Anyhow, I recently read an analogy written by Peter Lazaroff, a Forbes Online contributor, that I thought highlighted well the difference between fiduciary and suitability:
“Imagine you need a new car, but you don’t know much about different options. You head to the closest car dealer, which happens to be a Ford dealership. The dealer asks you to describe what kind of car you need, and you begin listing features and attributes that are best described as a Toyota Highlander.
Under the suitability standard, the dealer could say, “A Ford Explorer would meet all of your needs and we have some of those right over here.” The dealer makes the sale and gets the commission. You have a car that is suitable for your needs, but it isn’t necessarily what’s best for you. Since you don’t have a great deal of knowledge about the auto market, you are in the dark.
Under the fiduciary standard, the dealer would be obligated to say, “It sounds like you are describing a Toyota Highlander. We don’t sell those. In order to get exactly what you described, you would have to go down the street to Toyota and ask for a Highlander. I can sell you a similar model called a Ford Explorer, it’s more expensive and it isn’t exactly what you described.” In this scenario, you have more information about your options and the conflicts driving the dealer.
The Ford dealer has a clear conflict of interest in this situation. He can only sell Fords and will lose the opportunity to earn a commission if the client buys a Toyota Highlander. Under the suitability standard, the client ends up with a product (Ford Explorer) that isn’t the best fit given their situation and it costs more than the better-fitting product (Toyota Highlander). Worst of all, the client probably has no idea that they weren’t given advice that put their own interests first.”
Graham Bodel is the founder and director of a new fee-only financial planning and portfolio management firm based in Vancouver, BC., Chalten Fee-Only Advisors Ltd. This blog is republished with permission: the original can be found on Bodel’s blog here.