You likely haven’t paid much attention to the new fiduciary rule being put forth by the Department of Labor. It’s been four years in the making during which time it has been put forth for rigorous review and comment. And quite a political football. The rule basically states that advisers to retirement plans and 401K’s should be obligated to put client interests first. The audacity! Do you see a problem with that? Unless you are clear on how the financial industry is structured, the industry and political opposition won’t make sense to you. Allow me to make you aware of the debate, because you should know about it.
What’s the Motive?
The financial advisory industry is roughly divided into two different business models.
On the one hand, the registered investment advisor model (RIA), is the fiduciary model, and is based on fee-only compensation and imposes a legal standard on the adviser to “put the client interest first.”
On the other hand, the brokerage industry model, which dominates in size (and lobbying efforts) with about 85% market share, is a sales-commission driven compensation model based upon a “suitability” standard. The suitability standard is uhhh…let me say it kindly. Fluid. It’s a watered down nothing that allows the broker/adviser a lot of wiggle room to sell products that are clearly not in the best interest of a client. But they don’t have to be if they’re suitable. Make sense?
Clear Disclosure: What’s There to Hide?
Financial consumers are often confused on the difference between an adviser and a broker. Lending to this confusion, brokers now call themselves advisors and wealth manages and consultants, etc. – due to the rash of books and movies like “Boiler Room” and “Liar’s Poker” which highlighted the perverse practices and incentives that drive the commission-based broker models.
It’s not a black and white moral argument here as some would have you believe. That is, some believe fiduciaries are all good; brokers are all bad. Such is not the case. There are bad fiduciaries and there are conscientious brokers. However, it is a case of incentives being misaligned with the client good and the potential for mischief is much more prevalent in the sales-driven model. Your view of human nature may be more benevolent than mine. However, history and my own experience inform my view. If one is incentivized to sell a higher priced fund or insurance product, when a lower cost fund would serve the client better – guess how that one usually turns out.
On the third hand, there is a hybrid model, also known as dually-registered whereby an advisor can collect a fee and generate sales commissions. This further confuses many financial consumers, largely due to poor and inadequate disclosures. The DOL initiative is quite welcome in that it attempts to clear some mud (at least in retirement accounts).
To the Point
The DOL, in this adviser’s humble, reasoned opinion, has simply drawn a line in the sand as a matter of public policy. Skip the politics and follow the money. IRA’s and 401K’s are a key component of most people retirement income. If they can’t get unbiased advice and reasonable fund lineups for their retirement accounts many will not retire well. And that’s the point of the Rule.
All investments are subject to risk, including possible loss of the money you invest. Diversification does not guarantee profit or protect against a loss. Nothing herein or elsewhere on this site constitutes investment, legal, or tax advice. Please see the Disclosure link at the bottom of the page for more detail at www.compoundvalue.com/disclosure/.