Dropping Knowledge: Investment Suitability

February 3, 2011

In an earlier post, I promised that I would discuss investment suitability.  This is a common sense concept, but often overlooked by investors.  Under Financial Industry Regulatory Authority (FINRA) rules, your broker has an obligation to recommend suitable investments for you.  Specifically NASD Rule 2310 (which FINRA currently uses and will soon be updated):

(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:

(1) the customer’s financial status;

(2) the customer’s tax status;

(3) the customer’s investment objectives; and

(4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.

So, before recommending any investment, your broker has to take all of these factors into consideration.  Did your broker do this analysis?

But this also begs the question: What is suitable?  Well, it depends on your current situation.  For instance, if you are a young professional making $250,000 a year, do not have kids, and have a large trust fund backing you up, you may have different investment objectives than, say, a retiring auto worker with three kids and a mortgage.

It’s an individual question, but it’s worth making sure your portfolio lines up with what you (not your broker) is trying to accomplish.

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