Here’s a question: Is the broker who advises you on your retirement account on your side?
The answer is at the heart of the debate over the proposedDepartment of Labor fiduciary rules. Applying a fiduciary standard means the broker must put his customer’s interests ahead of his own. This is different from now, when nothing stops a broker from selling you what earns him the highest commissions, even if it may not be the greatest investment for your retirement plan.
The impetus for the impending change comes from the Securities and Exchange Commission’s Study on Investment Advisers and Broker-Dealers, which was required by the 2010 Dodd-Frank Act. We will learn precisely what the Labor Department plan is when it releases the proposal on Wednesday.
At stake are $17 billion in annual fees that the financial industry overcharges for advice on retirement-saving plans, according to the president’s Council of Economic Advisers. Compound those fees over the next 30 years, and those costs amount to trillions of dollars that are subtracted from investment returns, which in turn will be reflected in shortfalls for millions of future retirees. The White House’s concerns are that these costs might very well fall onto the backs of taxpayers.
The fiduciary rules for financial advisers are simple and easy to follow. Best of all for investors, conflict-free advisers are much less expensive. As Bloomberg Gadfly’s Nir Kaissar observed about the fiduciary standard, “What could be simpler or less objectionable?” The answer seems to depend upon which side of that $17 billion you are on: paying it or receiving it.
That is a big deal, for as we learn from Economics 101, incentives matter. Without any regulatory restrictions, advisers all too often end up selling whatever earns them the most. The whole business is a gnarly mess of overpriced products and compromised advice, without a lot of transparency.
My colleague Tony Isola, a former teacher who has spent much of his career advising other educators about their finances, notes that he sees this every day: “Annuities in IRA accounts with high internal costs and onerously long surrender charges” as well as “recommendations for products such as proprietary mutual funds with hefty trailers and high expense ratios.” His expectation is that the new fiduciary rules will prevent those products from finding their way into retirement accounts.
Other countries have looked at the issue and they came up with even stricter rules. The U.K. put a hard cap on retirement-plan fees. The U.S. hasn’t gone to that extreme, as far as we know, but we will find out Wednesday what the precise rules are. It is widely expected to require that:
- All fees be transparent;
- Any conflicts of interest be disclosed;
- The best interest of the client be paramount.
That seems like a rather reasonable set of standards for financial advisers.
Antiregulation advocates have claimed markets would correct this without government intervention. That has yet to happen. Indeed, to the contrary, we have seen fees creep higher in the 40-plus years since the federal laws governing retirement accounts were enacted.
Market forces are up against several challenges:
- Information asymmetry creates confusion among consumers about complex financial issues and products.
- Many investors aren’t even clear about whether their advisersactually are fiduciaries, one study says.
- Responsibility for managing 401(k)s lies with employers, creating a further layer of complexity.
There are signs that some market forces are moving in the right direction: just see the rise of indexing, exchange-traded funds and the $3 trillion in assets Vanguard Group has under management. But all of that is just a drop in the bucket compared with the trillions of dollars in 401(k) and other retirement accounts.
Thom Donlan, writing in the usually fiercely antiregulation Barron’s, observes that “In law-making as in investing, there are people who keep themselves free of conflict of interest, people who rise above conflict of interest, and people for whom conflict of interest is a way of life well worth defending. Until the nation raises better investors, it will have to try to regulate the predators.”
The fiduciary rule is a good start down that path.
Originally: Your Retirement Adviser Will Think of You First