In a previous post, we discussed how fee-only financial planners provide counsel without particular conflicts of interest; fee-only financial planners are not driven to sell various financial products for a commission. With a fee-only planner, you’ll never receive a sales pitch under the guise of financial advice. However, that may not be the case with a salesperson working for a commission, i.e. a broker, insurance agent, etc.
This begs the questions:
- Why are brokers and other sales people allowed to push their products under the guise of providing financial advice?
- How can this be legal?
The reason that brokers and other salespeople are able to do so is because these parties are only subject to the standard of suitability – not the higher standard of fiduciary, discussed later. To understand the concept of suitability, consider an example that many of us can relate to: weight loss.
Concerned about his growing waistline, Oliver Hardy seeks weight loss counseling services from his local pharmacy. Without asking about Hardy’s eating habits or exercise regimen, the pharmacist immediately offers to sell Hardy an assortment of diet pills.
Relative to the suggestions of the pharmacist, would Hardy be better off on an exercise regimen; and a diet of whole grains, raw fruits and vegetables? Absolutely! However, this is not the suggestion the pharmacist makes.
So, if a healthy diet and a regular exercise regimen is the best solution for Hardy, are the weight-loss supplements “suitable” for Hardy? With the diet supplements, it is certainly possible that Hardy could lose weight. Further, it’s not as if the pharmacist is selling Halloween candy to Hardy. However, while the pharmacist’s solution is suitable, there are more appropriate options: i.e. diet and exercise.
[subtitle3]Suitability In Financial Services[/subtitle3]
If a particular financial product – be it permanent life insurance with long surrender periods, or a mutual fund with a high sales load – is deemed suitable for the financial planning client, the broker can legally sell it. Even if the financial product sold generates a poor rate of return, the financial product sold can still be deemed suitable. Let’s return to a previous blog post’s example in financial services:
Hardy’s good friend, Stan Laurel, is nearing retirement. Laurel is looking for a way to invest his money. Considering his goals, liquidity needs, and investment time horizon, Laurel’s broker sells Laurel several high-cost balanced mutual funds with large sales charges.
In this example, the particular product offered for sale is a balanced fund, offering a split between the safety of principal and the potential for growth. Is this high-cost, high commission, product suitable for Laurel? Just like the pharmacist example, the answer is “yes.” So, even though the product is rife with high expenses, it is suitable because of the underlying investment product – which offers a balance between growth and safety for the new retiree.
Now that you’re clear on the broker model and its accompanying standard of suitability, let’s talk about the other side of the coin: the fiduciary model. To illustrate the concept of a fiduciary, let’s go back to our Oliver Hardy example:
Dissatisfied with the results of diet pills, Oliver Hardy seeks weight loss counseling services from his primary care physician. After asking Hardy a few questions, the doctor learns that Hardy has a strict diet of Luther Burgers (a cheeseburger with doughnuts for buns), and a daily routine of binge watching 10 hours of reality television.
As expected, the doctor puts Hardy on a healthy diet and a regimen of regular exercise. This is because the doctor is directly compensated by Hardy for a fee. Hardy’s doctor is not compensated by the sales of diet pills, Halloween candy, or otherwise.
[subtitle3]Fee-Only Financial Planner: a Fiduciary in Financial Services[/subtitle3]
You will note that the fiduciary model is in stark contrast to the suitability model; the fee-only financial planner is compensated directly by the client – and not indirectly compensated from various commissions that the client pays when purchasing financial products. In this fiduciary model, the financial advisor is legally obligated to act in the client’s best interest. This legal obligation requires the fee-only financial planner to work for the client – and not for themselves.
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If you’re working with a broker, commissioned financial advisor, or other financial services salesperson, consider getting a second opinion from a fee-only financial planner. A fee-only financial planner is able to present an unbiased perspective on your unique financial circumstances.