The Labor Department proposed new rules today that would require that brokers or financial planners or other professionals giving advice to individuals on their retirement savings act as fiduciaries.
what a fiduciary is
Being a fiduciary means being legally bound to give advice that’s best for the client, without regard for any benefits the adviser might get for recommending one investment over another.
Strangely, in my view, the fiduciary standard is not the rule advisers work under now. Rather, advisers are only required to recommend products that are “suitable” for customers, meaning they fit the client’s goals, financial circumstances and risk tolerances.
Another way of saying the same thing, the fiduciary is required to do what’s best for the client; under the old standard the adviser has simply got to avoid products that damage the customer.
A broker/planner has two general equity fund offerings:
–Fund A has a long history of strong investment management, consistently beating the S&P 500, and charges low fees
–Fund B has weak managers and an equally long record of sub-par investment performance, consistently losing to the S&P. It also charges fees that are double the size of Fund A’s. However, Fund B offers higher commissions to brokers who sell its product, plus trips to weekend informational seminars at resort locations to those who sell the most of it.
Under current rules, a broker/planner is permitted to recommend B over A, even though B is only better for the broker, and will presumably be considerably worse for the client.
costs are the smoking gun
Other than in hindsight, it may be hard to say whether manager X is better than manager Y. And managers who consistently underperform are eventually culled, even in retail brokerage houses, where the emphasis is typically on strengthening the sales force, not the portfolio management team.
But I think it would be hard for a fiduciary to defend recommending one so-so product over another that costs half as much, and for selling which the fiduciary gets gifts, trips or a corner office and a secretary.
traditional brokers will be hurt the worst by these rules
That’s because they charge the most–partly to compensate highly-paid salesmen, partly to fund an expensive network of retail sales offices.
The traditional retail brokerage business has been dying a slow death since the advent of discount brokerage services in the 1970s. Imposing a requirement that brokers do the best for their clients is another nail in the coffin.
for now, the rules only affect retirement savings accounts,
…not general savings/investments. I presume this limitation is the result of fierce lobbying by financial advice providers opposed to the fiduciary standard. But we may just be seeing the thin edge of the wedge.