There is quite a bit of buzz about the status of advisers in the financial services world. The Department of Labor is pushing to require an adviser to employ a fiduciary standard when providing guidance to their clients on retirement assets (both IRA and employer based plans). This has actually been a debate for some time now. However, the President has weighed in recently supporting a fiduciary standard for retirement advisers so it has gotten increased attention.
With a fiduciary standard, an adviser is required to act in the “best interests” of their clients. On the other hand, a broker/dealer is only required to provide recommendations that are suitable for the client. As such, the argument is that a client will always be better off by working with someone that is working in their best interests. That sounds right, doesn’t it? I am not sure it is and I think this argument misses the point.
An important aspect of the debate in determining what is suitable is adviser compensation. It is argued that if an adviser is paid on commission instead of by a fee directly from the investor, they are less likely to work in the client’s “best interest”. While certainly not complex, I don’t think it is quite that simple.
Let’s look at an example. Assume a 62 year old wants to (or is convinced to) transfer $250,000 from their low-cost 401k plan. How might two advisers handle this based upon whether or not they are a broker/dealer or a fiduciary? Adviser A, the broker/dealer, recommends the client transfer their 401k to A shares with American Funds and invest in a mix of bond and stock funds. We will estimate that the client pays 2.5% on the investment. That would total $6,250. The adviser gets a portion of that, right? (Some goes to the adviser and some to the firm). Good payday – but maybe the adviser has been providing service and guidance to the client for a long time and has “earned” it. The client still pays the ongoing management fees of the funds going forward. Also the adviser will continue to generate income in the form of trailer commissions on the account.
Adviser B, the fiduciary, recommends a managed program that charges the account 1% a year. That would work out to be $2,500/year. (Again, some of this fee goes to the adviser and some to their firm). But that fee would change as the size of the asset changes. As the asset gets larger, say it grows to $350,000, the annual fee is now $3,500. What a great income stream for the adviser! In addition, the client also pays the various fund fees used in the managed program.
So, which option is in the client’s best interest? First of all, was it even advisable that the client transfer their money from the 401k plan? Maybe it was, but maybe it was not. We indicate it was a low-cost plan. However, neither adviser is paid if they recommend that the client keep his or her funds in the plan. It doesn’t mean that an ethical adviser would not make this recommendation. However, they clearly do not have a financial incentive to do so.
It is obvious that the client will end up paying a lot more, and I mean a lot more, in fees with the fiduciary. Of course, the fiduciary will argue that they get all of this awesome service, investment guidance, and value going forward. Maybe they do, but couldn’t a broker provide this as well if they want to maintain and grow their business. Sure they could – and many do. So in which case is the client better off?
Frankly, I think both of these options are pretty crappy for the client. In both cases, they are paying too much for help. (They could leave the funds in the plan or use a well diversified index fund with Vanguard and be far better off in my opinion). But in both cases, the adviser has a strong financial incentive to promote the benefits of their approach, right? In fact, the fiduciary has a much stronger financial incentive to convince the client of the value of their 1% program, which continues to pay the adviser significantly year after year.
What I believe is most important is the total dollar amount of the adviser’s fee and how it is affected by the client’s decision, whether or not they are a fiduciary. In both examples, the adviser is well compensated – whether by commission or by fee. Fiduciaries have their own ”biases” and I get tired of fiduciaries promoting their “objective” advice while charging outrageous fees and claiming that they are working in the best interests of their clients.
FULL DISCLOSURE: PLANVISION IS A FIDUCIARY FOR ALL OUR CLIENTS. Regulation requiring a fiduciary standard would be, ya know, good for our business and all that – we would clearly gain from this requirement. But we would rather have our business promoted on its own merits than on misleading labels. We are proud of our model and how it supports our work with our clients. We decided to structure our business in this way for many reasons. However, it is not the idea that we can puff out our chest and call ourselves fiduciaries. We prefer being a fiduciary, but what is more important is the value we provide to clients at a low cost and how we have no financial incentive to push investors to invest their money in a certain way. So, in spite of the fact that it would theoretically be a boon to PlanVision if a fiduciary standard is required, we cannot get behind this.
By the way, while I am not a big supporter of this change, the argument of broker/dealers that the smaller investor will be left behind with this standard and no longer receive guidance is ridiculous. Give me a break! Whether or not this change goes through, there will always be opportunities for investors with modest portfolios to receive advisement. These investors don’t need hours of service, quarterly meetings, and endless reports they won’t read. They can do fine with straightforward, concise, affordable guidance.
In our recent Ebook How To Improve Your Employer’s 401K Plan, we encourage employers to work with a fiduciary. However, we are also careful to point out that there are many good broker/dealers and many overpriced fiduciaries. I have observed how “fiduciaries” make recommendations for products and ideas that I think are way overpriced. I also think they are guilty of many of the same misleading and ridiculous sales tactics used by broker/dealers. In fact, the word “fiduciary” might be one of the most overused words in the industry these days. It’s as if each firm is trying to outFiduciary every other firm.
Like everyone else, I do not know exactly how this will roll out (even though I think it will ultimately happen). I am not trying to be cute or contrarian with this viewpoint. I just don’t know if this will have the impact people think it might - it may have little effect on consumers. If people want real change, demand that all fiduciaries charge for their time instead of as a percentage of managed assets. I would be curious to see how many of the fiduciaries who promote the pristine nature of their model respond to that.
What do you think? Agree? Disagree?