June 4, 2020
Last week I wrote about the difference between the fiduciary standard and the suitability standard. I explained that brokers and brokerage houses are only required to give advice that is “suitable” for investors whereas Registered Investment Advisors (RIA) and Investment Advisor Representatives (IAR) are required to act in an investor’s “best interest.”
If you missed that column, go grab last week’s paper from the recycling bin, pick it up at the local store, or go here and check it out, because this conversation isn’t going away.
In fact, it’s just heating up.
Let’s start with a quick recap of the two standards as they relate to the financial services industry. The suitability standard requires only that a broker or advisor offer advice that is suitable to his or her client’s situation, which may or may not be what is also best for the client. The fiduciary standard, on the other hand, requires an advisor to always put the client’s best interests first. And look, please understand, I don’t mean to suggest that all brokers are only looking out for themselves. You may be lucky enough to have found one who puts your interests before his own, even if he is not required to. My goal is for you to understand the difference in standards and the questions you should be asking so you can determine that.
Other professions that are held to a fiduciary standard include Certified Public Accountants, physicians, and lawyers. In addition to putting a client’s best interests first, a financial professional held to a fiduciary standard must act with prudence, cannot mislead, and must fully disclose and fairly manage the client’s assets in the client’s favor.
I find that when people learn about the difference between the two standards, they often wonder how it is possible that one group of professionals is held to a significantly lower standard than another group of professionals in the same industry. Why wouldn’t everyone be held to the higher standard and be required to do what is best for their clients? Wouldn’t that make sense to help avoid any confusion?
Hmm. Well, the government has started to ask those questions as well.
The Department of Labor has introduced a new proposal, one that would require all financial advisors to put the best interests of their clients ahead of their own, even if it means less money in their pocket. Brokers would be required to recommend the best product, not just a suitable one that benefits the broker.
This proposal comes on the heels of research performed by the Council of Economic Advisers (CEA) that estimates the “suitability” standard can cost investors over 1 percent of their total return annually. In fact, a White House memo argues that investors lose as much as $17 billion annually in retirement dollars because of conflicted advice.
Want some even harder numbers to swallow?
According to the CEA, “A typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17 percent from her account by age 65.” Yep, you read that right. So, “if a worker has $100,000 in retirement savings at age 45, without conflicted advice it would grow to an estimated $216,000 by age 65 adjusted for inflation, but if she receives conflicted advice it would only grow to $179,000—a loss of $37,000 or about 17 percent.”
The White House recently released a fact sheet on the proposal that opened with a powerful statement: “A system where Wall Street firms benefit from backdoor payments and hidden fees if they talk responsible Americans into buying bad retirement investments—with high costs and low returns—instead of recommending quality investments isn’t fair.”
Now, you may be thinking, “Oh, that isn’t what’s happening to me, though.” Although, I hope that it is not, please know this, the report from the Council of Economic Advisors also stated that an estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest.
It isn’t just the CEA that found startling results. A strong set of independent research also shows that losses result from brokers getting backdoor payments or hidden fees for steering their clients’ savings into funds with higher fees and lower returns.
The Department of Labor has been tasked with putting forth new rules to protect investors. The proposed rules will require all retirement advisors to put their clients’ best interests first, expanding the fiduciary standard to apply to brokers. Second, the proposed rules will preserve the ability of working and middle class families to choose different types of advice. Lastly, it will preserve access to retirement education.
You might think, “Great, if things are changing, I don’t need to switch to an IAR or RIA. My guy will be held to the fiduciary standard.” And, although, I hope that will happen, you should know that this proposal won’t go through without a fight. According to the vice president of the Insured Retirement Institute, if the Department of Labor releases a conflict of interest rule based on expanding the fiduciary standard, it will be met with “swift and strong legislative action.”
Please note that this issue was first introduced to Congress in October 2010, and five years later nothing has changed. Potential conflicts of interest, compounded over five years, may have cost you significant losses. How much more are you going to miss out on, waiting for a change?