I'm
from the government and I'm here to help you.
Pardon
me but this isn't my first rodeo.
Who's
Making the Money?
Where's
Bogle when we need him?
A
different conflict of interest.
The Department of Labor’s fiduciary rule demands
that advisors who work with retirement accounts act in the best interests of
their clients, and put their clients' interests above their own. Working with a fiduciary makes sense for many
retirement planning activities. However, fiduciary is a higher level of
accountability than “suitability,” the standard required of financial
salespersons, such as brokers, planners and insurance agents. For most
activities related to ongoing management of a retirement account a salesperson
is totally appropriate, and in the case of the no-load mutual fund, even a
salesman is unnecessary.
Every investor has a right to an opinion about the
fiduciary rule, and most investors probably have an opinion. No doubt, that
opinion is influenced by the degree to which one wants to take responsibility
for making one’s own investment decisions and doing one’s own research.
However, some people do not realize that taking responsibility for making one's
own decisions and doing one's own research are probably the most important
fiduciary rules.
A disclosure is in order. My initial reaction to the
fiduciary rule was to wonder whether it was a hoax or a joke. The idea that the
government could pass a law that would force others to understand my best
interest seemed ludicrous. It also seems apparent that paying someone else to
try to understand something that is self-evident to me, my self-interest, was
going to get expensive. As Bogle has pointed out on numerous occasions,
investment costs are the enemy of successful investing. So, I was skeptical
from the start.
On 4/19/2017, the WALL STREET JOURNAL had an article
entitled “Wall Street’s Fee Bonanza.” It pointed out that even though the
fiduciary rule may not be implemented; firms were already shifting to a
fee-based service. The explanation is simple: the firms have found that fees
for advice and services could be more lucrative over the longer term compared
with commissions. “Researcher Morningstar Inc. says
fee-based accounts can yield as much as 50% more revenue than commission
accounts.”
The fiduciary rule would affect about $3 trillion
that brokerage firms oversee in tax-advantaged retirement accounts. Generally,
the fee under a fee-based management system is 1% or more. So, the rule would
introduce $30 billion of costs into the system. That $30 billion is not all new
costs since brokers were previously earning commissions that may be reduced as
a result of the fiduciary rule. However, commissions at brokerage firms have
been falling without the fiduciary rule, and mutual fund management fees have
been shrinking. Introducing this new fee is counter to the trend in the
industry.
Theoretically, the fiduciary rule would force the
brokers who oversee those accounts to act in the best interest of the clients.
Advocates of the fiduciary rule argue that it would address a cost of $17
billion a year in extra expenses that result from conflict of interest. They
base that estimate upon the existence of a lower cost “equivalent” investment
product. Critics of the rule dispute that estimate, but even if the estimate is
right, $17 billion is only about .6% of the $3 trillion in brokers’
tax-advantaged retirement accounts.
It's also worth noting that the $17 billion estimate
is not based on the $3 trillion in brokerage accounts. It's based on $6.8
trillion in defined contributions market. Using the $6.8 trillion figure and a
1% wrap fee, the cost could be $68 billion. Finally, even if the $17 billion
estimate is correct, there's reason for skepticism about how much of that
conflict of interest cost could be eliminated by the fiduciary rule.
As is pointed out in an April 8, 2017 article by
Jason Zweig in The Intelligent Investor section of the WALL STREET JOURNAL,
conflicts of interest is not so easy to identify, and they are much harder to
eliminate than simply passing a rule. The article was entitled “Conflicted And
Not So Free Of Friction” and concluded with the statement “the label ‘conflict
free’ can lull investors into dangerous complacency.”
He points out that anyone who provides a service
including financial advisors has a conflict of interest. “And you should be
wary of financial advisers who aggressively market themselves with the label ‘conflict
free.’ No matter how sincerely they may believe it, that description is
impossible.”
He then goes on to point out some of the “conflict
free” claims made by some firms. He gives an example where the claim is made
based upon not having proprietary products: “Because the firm has no
proprietary products to sell, … advisers can provide truly objective,
conflict-free advice and investment recommendations.” However, that language
refers to the relationship between the adviser and the company. Yet, people who
work for the company may receive special payments for
bringing clients with them from their former firms and may earn more when
clients invest in one product or service than in another.
The article quotes Brian
Hamburger, president of MarketCounsel, a firm that helps advisers comply
with investment regulations. He comments: “Conflict free is good marketing. But
it is a bad description of financial advice, because it can lull investors into
dangerous complacency.” He then gives some examples:
“Some financial advisers charge
higher fees to manage stock than bond portfolios: That’s a conflict. Advisers
can earn more if you take a rollover from a 401(k) retirement account than if
you leave the money where it is: That’s a conflict.”
“Many advisers charge fees on
money-market mutual funds but not on a certificate of deposit you hold at a
bank. Not surprisingly, they often favor money funds over CDs even though CDs
can offer higher yields, and that’s a conflict.”
A conflict of interest can arise from
something as simple as which product requires the least paperwork. In the case
of the heavily regulated industry like investment advisories, it can arise from
the amount of paperwork required to comply with regulations. With the fiduciary
rule, the risk of lawsuit undoubtedly would create conflicts of interest
between what best serves the client and what minimizes the risk of lawsuit.
The fiduciary rule is not going to relieve
investors of the necessity of doing their own due diligence. The investor still
needs to know exactly how the adviser is compensated if conflict of interest is
a major concern. However, conflict of interest should not be a major concern.
The major concern is whether the investment is consistent with the investor’s
objectives and competitively priced. An adviser may be selling a product that satisfies
the investor's objectives even though the adviser is consciously pursuing his
own self-interest.
It just seems
inappropriate to potentially introduce $30 billion or maybe $67 billion in cost
in order to eliminate what might be as little as a few billion in conflict of
interest costs that can be eliminated. So, there has to be some other
justification for introducing that cost.
Higher fees may well be justified if they are
associated with the higher-level service. Under this fiduciary rule, people
managing retirement accounts will have to spend more time trying to understand
the client’s full financial situation. It would be unfair to fee-based advisers
not to acknowledge that they put considerable effort into understanding the
investor’s risk tolerance and personal circumstances. Some advisers are
probably very good at it, but others will undoubtedly just be filling out forms
in order to check the boxes they need to check in order to protect themselves
under the fiduciary rules. However, not all investors need expanded services.
So, why make every investor pay for them?
Further, my reaction is colored by the fact
that I seriously considered and looked into what is required to get the
designation Certified Financial Planner, and I also studied the requirements
for a Series 65 license. My conclusion from those experiences was that, rather
than improve one's ability to give good financial advice, the regulations
introduced a different conflict of interest. That different conflict of
interest doesn't preclude giving good financial advice, but it is a conflict of
interest between giving advice consistent with regulations versus giving the
best advice possible.
Lest all those with a CFP or Series 65 license
grabbed their pitchforks and ready the tar and feathers, I want to make it
clear that I believe that a fee-based advisory service for financial planning
makes sense. So much so, that I invested the time and effort to study the CFP
and Series 65 requirements in order to learn more about how to do it. However, using
a fee-based advisory service to set up a financial plan is different from
ongoing investment advisory services. Many fee-based advisers with the CFP or
one of the other designations won't even recommend specific financial products;
rather, they'll identify what's needed in generic terms. It's then up to the individual
to decide whether those products are appropriate and which products to
purchase.
Financial planners provide a tremendous
service by showing their customers/clients how to go about setting up a
financial plan and helping their clients do it. However, that's quite different
from the fiduciary rule that's currently being considered. The fiduciary rule creates
the mistaken impression that the financial adviser, because he or she is a
fiduciary, can develop as well as implement a financial plan for you. Further,
it ignores the issue of whether complying with the fiduciary rule increases the
cost of investment management to the point where the fiduciary rule itself
conflicts with acting in the best interest of the client by increasing the
cost.
Many advisers with the CFP or similar
designation pursued the designation out of a desire to provide conflict-free
financial advice. That, however, is quite different from a large corporation
switching all of its brokers from a commission-based compensation scheme to
fiduciaries so that they can have access to large amounts of money for the
company to manage. In essence, the fiduciary rule may have shifted the
fiduciary designation from a benefit of working with a fiduciary to a marketing
program for large brokers.
Some investors undoubtedly need to be
protected from their own financial advisor. Others find it far less expensive
to just dispense with the financial adviser totally. It would seem to make
sense to let the investor select the type of financial adviser that best suits him
or her. However, there is the potential for the fiduciary rule to be justified
because of an adverse selection process. Those who need the protection of the
fiduciary as a financial adviser may also be those who have to have it forced
down her throat.
For example, common sense would dictate that
one would save and invest for retirement. Yet, one of the greatest benefits of
pensions is that they force savings and investment upon individuals who
otherwise might not save and invest. Similarly, default 401(k) enrollment and
even mandatory 401(k) offerings by employers have many advocates among those
who have looked at the issue. So, absent the fiduciary rule, the negative
impact might be concentrated among the least financially savvy participants in
retirement programs and those least able to avoid the appeal of the sales
pitch. However, it would have no impact on those who are so financially
unsophisticated that they don't even participate in retirement programs.
However, that raises yet another question and
potential objection to the fiduciary rule. If the fiduciary rule benefits
primarily the less financially sophisticated, there is an increased potential
that acting in the client's best interest would involve forcing them to
purchase a product they don't understand. That raises the question whether a fiduciary
should sell someone a product that they know the purchaser doesn't understand.
Again, pensions provide an example. Many
pension participants understand only that the pension involves a promise to
pay. They have no concept of the importance of the ability to pay or the role
of the pension fund, and often they haven't the foggiest idea where the pension
is investing.
It
would seem that the fiduciary rule has the potential to harm a significant
number of investors by increasing the cost of investing in a retirement
account. Those most likely to
be negatively impacted may be sufficiently financially sophisticated to figure
out a way to avoid the costs. However, it
would seem more reasonable to use the fiduciary rule as a default status while
allowing an option to opt out.
Despite the inappropriateness of the fiduciary
rule as currently being considered, there is ample room for improving how
retirement accounts are run. It is a common complaint that fees associated with
401(k) and other defined-contribution accounts are too high and opaque. However,
the high cost and opaqueness are as much a product of the structure of the
programs as a conflict of interest. Further, what is true of 401(k) programs isn't true of all
retirement accounts. There's no evidence
that self-directed IRAs require a fiduciary broker. A fiduciary is appropriate
for some investors and not for others.
Placing
the emphasis on providing participants with accurate information on 401(k)
programs, especially all costs, may be far more productive than the fiduciary
rule.
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