Broker vs Fiduciary: What are the Differences?

Broker vs Fiduciary: What are the Differences?

If you are investing for your future you will likely need the help of financial professionals to help guide through what can be a complicated process. For example there are lots of rules and regulations that you must follow in order to be legally compliant when planning for your retirement, which we will look at later, and so 2 of the most common ones that might help here are a broker vs fiduciary.

They each have their own set of regulatory standards governing their behavior, so let’s take a look at the differences between them: 

Broker vs Fiduciary What are the Differences-Fiduciary

What's the difference between a Broker and a Fiduciary?

A Broker is a person who buys and sells securities, such as shares, on behalf of their clients and are typically paid through commissions or fees charged for their services. 

A Fiduciary, on the other hand, is a person who is legally bound to act in their client's best interests and are usually paid a flat fee for their services.

Let’s examine these differences in more detail and how they may affect you:

The Fiduciary Standard vs The Suitability Standard

A Broker is held to a suitability standard which means that they can only recommend investments that they reasonably believe are appropriate for the given situation. 

The full text of the suitability standard is published by FINRA (Financial Industry Regulation Authority) and is rule 2111,  a broker must "have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer's investment profile."

Broker vs Fiduciary What are the Differences- FINRA

This means that so as long as the choices they give you are in the ballpark of what’s appropriate, then they are legally in the clear.

They can receive commissions on the investment products they sell to investors which can create a conflict of interest, for example, where a Broker recommends an investment that pays a commission instead of a better investment that does not pay a commission. 

These decisions can impact the investor, who may receive sub-standard advice from a Broker as the broker may not have the same incentive as a fiduciary to keep an eye on investment performance and fees.

A Fiduciary is legally bound to act in your best interest at all times, while a broker does not have to. The Fiduciary must disclose any conflicts of interest and make all details of potential transactions absolutely clear, while a broker does not. 

Furthermore, a fiduciary must recommend only the best investment for your needs, while a broker may recommend a financial product that is not necessarily the best fit for you.

Fiduciaries: The higher standard of care

A Fiduciary is held to the fiduciary standard of care which legally requires the investment representative to act in the best interest of the investor. The fiduciary duty is the highest standard of care under American law, therefore it is higher than the broker’s suitability standard. 

The SEC sets out all the guidelines that a fiduciary must follow in their Commission Interpretation Regarding Standard of Conduct for Investment Advisers document.

Working with a Fiduciary can help you avoid many of the potential pitfalls associated with working with a Broker. 

First, because Fiduciaries are legally bound to act in their clients' best interests, you should be sure that any recommendations they make are the best for you and your particular set of financial circumstances and goals.

Second, because Fiduciaries typically work on a flat-fee basis, they do not have any incentive to sell you one product over another. 

Often this flat fee can be substantially less than the fees a broker could receive because a broker could be getting paid a percentage of your portfolio, and if your portfolio is large then obviously their fees could be large too.

Finally, because Fiduciaries are required to disclose their conflicts of interest, you can be confident that you are aware of any potential conflicts before making any decisions.

Broker vs Fiduciary What are the Differences-SEC

This means that you can ask the financial professional you are dealing with  “How do you get paid?,  Is it based on commission?”

If the answer is yes, then you’re dealing with a broker.

If you want someone to manage your investments, including choosing which stocks, bonds, mutual funds to invest in, then you it’s better to hire a true fiduciary advisor. 

A fiduciary does not require your consent on any trade, although you should definitely receive regular statements and trade information through a third-party custodian.

Whereas a broker cannot legally trade any assets in your portfolio without your consent. You must give them the order to do so first. 

Therefore, no matter how much they may seem to manage your finances, if the person you are dealing with has to run any kind of trade by you, then that professional is a broker and not a fiduciary.

The Importance of Hiring a Retirement Plan Fiduciary Advisor

Retirement planning is a complicated business and is arguably the most important financial decision you can make. It is not wise to do all this planning yourself as you must remain compliant with al laws and taxes, and naturally this can be too much for an amateur. 

It is a good idea to hire a professional who specializes in pensions/retirement planning and this is true whether you are an individual investor or a business owner with a 401(k) plan. 

While there are many different types of financial advisors out there, not all of them are created equal. One type of advisor that you may come across is a retirement plan fiduciary, who is a financial advisor who has a legal obligation to act in your best interests.

In general there are two types of fiduciaries in the financial world: investment fiduciaries and ERISA fiduciaries.

Investment fiduciaries include financial advisors, brokers, and registered investment advisors (RIAs).

ERISA fiduciaries are a type of fiduciary that is specifically designed for retirement plans.

Broker vs Fiduciary What are the Differences-ERISA

ERISA is the Employee Retirement Income Security Act and is a federal law that was enacted in 1974. ERISA sets out minimum standards for employee pension and health plans, including rules about participation, investing, and funding. 

It establishes fiduciary responsibilities for plan sponsors and administrators, and provides for certain participant protections, such as the creation of a grievance and appeals process. 

While ERISA does not mandate that employers offer employee benefits plans, it does provide guidelines for those who do choose to offer such plans.

This means that ERISA fiduciaries are required to have a thorough understanding of retirement planning and they can provide you with the expert advice and guidance you need to make the best decisions for your retirement.

A retirement plan such as 401(k) plan can be complex and time consuming for a plan sponsor. You can read more about Roth 401k vs 401k for High Income Earners here.

Some people decide to hire outside advisors to help the plan stay compliant with IRS and ERISA laws and so it is crucial to understand the difference between hiring a broker versus hiring a fiduciary.

Now, you might be also interested in What is an Investor Day?

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