The US court of Appeals recently struck down the Department of Labor’s fiduciary rule, which required all financial professionals to manage retirement accounts with their clients’ interests ahead of their own. Now that this consumer protection has been vacated, it is important to educate yourself on the ins and outs of what makes a financial professional a fiduciary and why you should engage in a fiduciary’s services.
Do all financial professionals have the same obligations to their clients?
As a consumer, it is important that all the professionals you work with have your best interests at heart. You might assume that when you entrust a financial professional to help you maximize returns while mitigating your appetite for risk, that they will help you invest with your future in mind. However, this is by no means a given when it comes to working with non-fiduciary financial professionals, who have few legal obligations to ensure that you are invested appropriately. Non-fiduciary advisors can recommend investments with much higher fees, riskier features, and lower returns, all while misleading you throughout the process. Non-fiduciaries do not have to disclose their conflicts of interest, an example of which might be their necessity to push a limited set of high-fee investment vehicles for them to receive commissions or bonus compensation from their employer. Ultimately, it is very possible that engaging in the services of a non-fiduciary, might drastically impact your investment outcome.
So who and what is a fiduciary?
Like a non-fiduciary professional, a fiduciary is entrusted with the management of one’s wealth. What separates the two is that a fiduciary legally needs to put their clients’ interests first and foremost, always. Fiduciaries are required to be transparent, fully disclosing how they are compensated. When you enlist a fiduciary advisor’s services, they are obligated to mention any conflicts of interest or potential conflicts of interest both prior and throughout your engagement. All Registered Investment Advisors (RIAs) are fiduciaries, who adopt and hold themselves to a code of ethics and are required to file a form with the Securities and Exchange Commission annually. This form ADV discloses firm specifics such as service offerings, fees, investment style, assets under management, advisors within the firm, and any past disciplinary actions. These disclosure documents are extremely important, and we recommend that all potential clients read them carefully. This is a public record that should be available on an advisor’s website and RIAs will often offer this form to every potential client early in their engagement process. Any firm that does not make this document easily accessible or shows reluctance to offer it upon request should be treated with caution and we’d highly recommend looking elsewhere.
How did the fiduciary rule come about in the first place?
A 2015 report by the Council of Economic Advisers quantified hypothetical losses for consumers that were directly the result of conflicted financial advice on retirement assets. The report investigated one of the most common investment scenarios. An investor takes retirement assets from an employer plan and rolls them into an IRA. The report then relied on the results of 10 previous academic studies, which looked at differences in the performance of assets with conflicted advice vs. unbiased advice. They came up with the following scenario as a representation of what would generally happen if an uninformed investor transferred their employer plan into an IRA with conflicted advice. Based on the studies they reviewed, the report estimates that the average rollover to an IRA with conflicted advice would give up 1 percentage point of performance annually in fees alone. These excess fees are shown in the following chart.
|401(k)||IRA with Conflicted Advice|
|Portfolio’s gross return||6.50%||6.50%|
|-Mutual Fund Expenses||0.20%||1.30%|
|-401(k) Plan Expenses||0.25%||0.00%|
|Saver’s Net Return||6.00%||5.00%|
The report estimated that there are $1.7 Trillion of US household IRA assets in products which generally have conflicts of interest, so the afformentioned 1% annually represents $17 Billion of lost opportunity for consumers. Because of these findings, the Department of Labor under the Obama administration announced that all advisors of retirement assets should be held to fiduciary standards so hard-working Americans weren’t swindled out of their retirement assets. This fiduciary rule has since been overturned.
So what happens now that the fiduciary rule has been vacated?
A lot of news outlets are saying that even the short period in which big Wall Street brokerage firms were putting the infrastructure in place to comply with the fiduciary rule has created a new fiduciary standard. It has been speculated that these large companies are not going to back away from their investments of resources and money toward regulatory compliance, especially since the industry might be heading down this path in the future. We hope this is true and that everyone who handles money, especially retirement assets, will operate in the best interest of their clients. But truth be told, there are still many non-fiduciary advisors out there who can give you conflicted advice. The same study above put their research findings into a more personal scenario. As mentioned previously, that estimate of a 1% lower annual return over a long-term investment period will dramatically reduce investment growth. One percent doesn’t sound like a lot, but how it can affect you is staggering. The study estimates that a retiring employee who transfers over their employer plan to an advisor who gives conflicted advice will on average have access to 12 percent less savings annually when their account is drawn down over 30 years. If this person opts not to decrease their planned distributions by 12%, then their money will run out 5 years sooner.
When you consider a mid-career 401(k) rollover to an IRA with conflicted advice, the effect is even more dramatic. That 1% annual difference would cause a 45-year-old to have 17% less savings at age 65 than if they had just left it in their old employer’s 401(k). Essentially, people and companies will continue to profit at the detriment of you and your retirement if you allow them. We recommend always working with someone who is legally obligated to have your best interests at heart for all your accounts. If you need help finding the right fit, feel free to use this NAPFA advisor comparison tool, which can help you ask the right questions.