Peace Of Mind A Litmus Test Of Fund Suitability
By Marcella De Simone
An advisor who is deciding whether to place a client’s money into a certain mutual fund can follow a simple litmus test: will my client be able to sleep at night.
Thats how Joe Sciabica, CFP, New York, decides whether an investment is suitable.
He defines suitability on a case-by-case basis, but, in general, chooses “an investment program that is consistent with an individuals investing experience, with his investment time frame, with his understanding of what different types of risk are.”
People often mistake risk for volatility, Sciabica says. “Suitability relates to all the different types of risk, not only market risk but also inflation risk, credit risk, interest rate risk.”
The responsibility of explaining all of this to the client is the advisors, Sciabica says, but the responsibility does not end there.
“Its absolutely, positively, unequivocally the individual financial professionals responsibility to know his or her client, to know about his experience, objectives and to understand whats going on in his financial life.”
But, Sciabica concedes that no matter how much an advisor does to ensure the best possible investments are made for his client, he remains exposed to a lawsuit.
“When youre dealing with someones financial life, irrespective of what the security is, youre always open to (a lawsuit) because we live in a litigious society. If people feel they were wronged, its not unlikely they will turn around and sue.
“The agents protection is understanding his client and making sure they understand he knows what he is getting into.”
Sciabica also suggests putting together disclosures for the client to sign confirming that he understands the type of investment and the level of risk, and that the alternatives have been explained to him.
The same standard of suitability applies for life insurance sales, Sciabica says, “because when youre talking about soliciting any financial service, youve got to clearly understand your client and his experience and objectives.”
An advisor who is not apprised of everything a client does regarding his financial plan is at a disadvantage, Sciabica says.
“Purchases a client makes affect other aspects of his finances, and he has to understand what mutual funds will do to his taxes, what owning life insurance is going to do with his estate planning.
“Im a big believer of not making financial decisions in a vacuum.”
Hugh Alexander, a lawyer with Alexander Law Firm, Denver, says that the producer is responsible for determining the suitability of a sale because he can gather information at the point of sale.