Under a recent report that was developed by the President’s Council of Economic Advisors, it was shown that on average Americans overpaid $17 Billion/year of unnecessary feesand commissions or on average lost 1% return each year to brokers, who are not necessarily working with the client’s best interests. The Department of Labor, the President and primarily AARP are pushing to change the rules so that all advisors that advise on retirement accounts to be bound by the Fiduciary duty, as explained below.
So what does this all mean? We set up our FREE Investment Education Seminarsbecause we believe and know from our conversations with clients, friends, relatives and prospective clients that the knowledge about investments and investing wisely or rationally is either not here at all or skewed widely by financial media that promotes one stock versus another and by other ‘noise’ that we hear daily talking to people, friends and supposedly ‘experts’. Most people are very confused about their choices, the widely varying investment products as well as the best strategies to invest for the long term. Usually the short-term thinking takes over and for most people it’s demonstrated as a major underperformance, compared to just a simple ‘Buy, Hold & Rebalance’ approach or a simple index. Please see below for the 20 year performance of a retail investor compared to other much simpler indexes. At almost 7% underperformance per year versus the S&P 500 Index, that could mean thousands of money left on the table, and the big difference between achieving your goals or not.
The war I’m currently talking about has to do with this recent proposal that the Department of Labor is trying to establish the type of advisor that can provide advice to clients about their retirement accounts. As I’ve mentioned to some of you in a recent seminar, there are currently two standards that current financial advisors can provide advice to clients. They are known as a) Fiduciary Standard and b) Suitability Standard. To most people just these few words definitely don’t make any sense, so they need to be explained. A Fiduciary Standard, which covers our firm as well, is one where the advisor has to put client interests’ first, before their own profits and provide advice with those principles in mind; in a simplified version to provide advice to clients just like he would provide advice to himself, the best advice, best products available at the best price possible. Under this platform the advisor charges the client, usually a percentage of assets under management and interests are aligned, the client wants to get higher performance, but so does the advisor, as a happy client means a stable client and a longer relationship. The client and advisor’s interests are aligned, both working towards making the most possible for the client.
Under the Suitability Standard, which fits most large financial & brokerage institutions, including some of the best known brokerage houses, the brokers are simply providing ‘suitable products, based on the situation of the client’ but they’re not required by law to serve in the best interest of the client, or disclose potential conflicts or interests, meaning they can provide and sell a product to a client even though a similar product may exist at a cheaper price. The reason this is done is due to commissions that they receive promoting one product versus another, and of course the product that pays the most will tend to be promoted the most. That is exactly where you have most potential conflicts of interests where the broker gets paid by a third party and not necessarily the client. Under this scenario the interests of the broker and client are not aligned, as the broker can only maximize his fees by choosing to put the client in a higher fee product, eating away from the client’s performance, even though a lower fee product already exists and is a perfect substitute.
Understanding the two systems, one would ask ‘How is it even possible that they can both co-exist?’ and ‘Why would a client pick the ‘suitability standard’ if in general may not be in his best interest?’. The answer lies with the enormous size and power of the main financial institutions that also have brokerage operations and their dependence on fees and commissions to survive, but primarily on the clients’ misinformation or non-education of the above concepts and ideas as well as a desire to outperform the market or buy the ‘winning fund’ that has been hyped-up by recent good performance, and some broker is definitely selling that one at a hefty fee.
This has been going on forever, and still most people don’t know how to distinguish the two different advisors, as they both use interchangeable names and could be found as ‘financial advisors’, ‘investment advisors’, ‘financial representatives’ etc., but recently, the Department of Labor is promoting to put a new rule in the books, simply saying that any advisor that is advising retirement accounts should act under a Fiduciary rule, i.e. act in the best interests of the client.
Now, why should there be a war on this? Knowing that we’re trying to make advisors responsible and align their interests with those of clients should make sense, no? Well, the big brokerage houses clearly don’t like this one bit, as their commission business and putting clients into products that pay them the biggest commissions will completely disappear, at least for the retirement accounts. We already see articles putting fear into clients or readers that if this law passes costs will increase and availability of advisors will be reduced and so forth. We just don’t believe that at all.
Lead Advisor, InvestEd.