The cost of good financial advice

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A sign in a corporate IT office once read, “Advice: $10. Good Advice: $1000.”

It’s obvious that when it comes to certain things, you do get what you pay for. In the investment advice industry, however, the amount you pay for insight may not necessarily be based on the quality of the advice, but instead on the compensation plan of your investment advisor.

A new Department of Labor (DOL) regulation known as the “fiduciary rule” is slated to take effect in April, and it seeks to change this scenario.

There’s no argument that President Trump’s election has had a profound positive effect on procyclical and financial sector stocks, the drivers of which are tied to his pro-business policies and infrastructure spending plans. The president’s pro-business policies include reducing financial investment advice regulation. Early in February, Trump signed an executive order delaying the implementation of the DOL fiduciary rule.

Now, many are weighing the pros and cons of such investment regulation.

What’s a fiduciary?

A fiduciary duty means putting the interest of your clients ahead of your own. The new DOL rule will elevate people and institutions providing investment advice for retirement savers to fiduciary status, a stricter form of what is currently required.

Currently, investment advisers need only provide clients with recommendations that they believe are suitable for them. The result of this “suitability standard” —intended or not — is that advisors may put their clients in higher cost vehicles because those vehicles benefit advisors and their institutions in the form of greater fees and commissions.

Reasons the rule is a good Idea

The Employee Retirement Income Security Act of 1974 (ERISA) rules were put in place to protect the traditional pension plan, which back in the early 1970s, were largely defined benefit plans. Now, most American middle class retirement savings are in 401(k) plans. While the retirement investment landscape has changed massively since the early 1970s, ERISA rules have not changed. This leaves the average, middle class family potentially exposed to self-serving advice from their advisers.

At a high level, the rule is intended to give the average retirement saver additional protections that large pension plans have enjoyed to date. This is a good idea since most retirement savings are now in individual accounts and no longer in the form of pension plans. The majority of today’s savers are not nearly as well equipped as pension plans and their staff.

The new rule will require advisers to disclose all fees and incentives in clear dollar form. Last year, the White House Council of Economic Advisers noted middle class investors lose $17 billion each year, or 1 percent lower returns annually, to improper recommendations, or to advisors looking out for their own interests rather their clients.

This is not to say that every adviser behaves this way, but a substantial number do. It is understandable that the industry, on average, does not want this new rule to go into place. This might be because $1.7 trillion of individual retirement account (IRA) assets are in investments that generate income for advisors that would, under the new regulation, be considered conflicts of interest and illegal.

Reasons the rule is not a good idea

As is usually the case with change, there are those that stand to benefit, such as the average saver, and those that stand to be constrained or burdened with additional regulation, such as the financial services sector. Some mutual funds stipulate fees or up-front sales charges which are used to pay for a mutual fund’s distribution costs and brokers’ commissions. If the rule goes into effect, the financial industry expects to lose about $2 billion a year in commissions from not recommending clients into funds that require fees and front-end load charges.

The new DOL rule is expected to increase compliance costs, especially among broker-dealers. Fee-only advisers and registered investment advisers (RIA) are expected to see increases in their compliance costs as well.

The rule could actually hurt competition when smaller investment firms unable to comply or afford  the new requirements ultimately go out of business or are purchased by other larger institutions. The new compliance rules may force some broker-dealers to divest themselves of representatives and 401(k) advisors because of the new compliance requirements. The result could be fewer advisors to serve the small plans of most middle class American 401(k) participants.

Those against the fiduciary rule argue that if they are required to disclose fees, the consumer will almost always select the lowest fee instrument, even if the potential returns are higher with a more lucrative advisor recommended option. The fiduciary rule limits advisers’ flexibility in offering a full array of choices, critics of the new rule say. This is particularly relative to the smaller investor. In other words, smaller investors who can’t pay for fees will have fewer investment options.

Who should get the money?

Like everything money related, both sides of an issue want to hold on to or make the most money they can. The idea is to get more for your money if you’re a buyer, and the seller wants more for his product. It’s market forces at work. We all want to get the most for what we pay and some things are in fact worth more than others. Whether the DOL fiduciary rule goes into effect or not, the best advice is always for the buyer to be aware.

Stuart Blair, CAIA, is director of research at Canterbury Consulting, a West Coast investment advisory firm overseeing more than $17 billion in assets for foundations, endowments, and families.

The views expressed by contributors are their own and are not the views of The Hill.

Tags Department of Labor Fiduciary Rule Finance investing Money Retirement
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