The Charleston, SC story of a local economist, Al Parish, has gathered much local interest and concern, so I decided to extend a bit on my lesson for investors...
I will not be a party to the dispute as to Mr. Parish's innocence or guilt but pay attention to the fact that many people have learned a hard lesson as a result of their own ignorance. I do not mean this as an insult to those investors who have potentially lost all or a significant portion of their life savings. Their mistake could have been made by anyone. I simply believe that a mistake is a philosopher's greatest tool for growth. Now let's do some growing...
My lesson today is for investors (and financial advisors) to learn the significance of what it means to be a "fiduciary."
First, we must understand that, a financial adviser, whether it is a stockbroker, banker, insurance agent, or investment advisor has, at a minimum, what is called a "suitability standard" of responsibility to their clients. This standard requires that the adviser recommend products that are "suitable" for the client. For example, a high-risk technology sector fund may not be suitable for an 80-year old person who lives on a small, fixed income; however, it may be perfectly suitable for a 25-year old with high risk tolerance that is investing for a 40-year time horizon. Now we have the basis of the "suitability standard." Where the suitability standard falls short is that the high-risk technology fund in our example could be the worst performing fund in the universe but it still meets the standard because it was "suitable" for the particular investor's objectives.
Here's where the "fiduciary" standard picks up:
- The fiduciary standard of conduct is demonstrated through a prudent, sound process through which investments are made.
- This "process," among other things, will involve selection, monitoring, and replacement of investments through the use of an "investment policy" that is consistently followed by the fiduciary.
- Fiduciaries have a legal requirement to act in accordance with applicable laws and are ultimately personally liable for their decisions.
- Essentially, the fiduciary is legally and ethically bound to keep the client's interests ahead of their own while practicing and documenting a diligent and prudent process in their investment selection and monitoring.
In our "technology fund" example, a fiduciary would be legally and ethically required to document the reasons for selecting the fund; to monitor the fund; periodically report the status of the fund to the client; and replace the fund if it does not meet the standards set forth in the adviser's investment policy.
Without a fiduciary standard, the investment advisor can "sell" the client almost any investment product, even if it is the worst in its class, as long as it is "suitable."
For information on how to identify a "fiduciary," read the following post, "A Fool and Your Money..."
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and financial planning.