The First Question You Need to Ask Your Investment Advisor
Jeff Clark, CFP®
Before ever investing with an investment advisor it’s important to know he or she has your best interests in mind. After all, you worked hard for your money. No one steps into an investment advisor’s office thinking, “I hope I can score this advisor a nice commission by paying extra fees for my investments.”
Sadly, many people unwittingly walk out of an advisor’s office after being sold less-than-optimal investments designed to enrich advisors at the client’s expense.
According to a recent study by the White House Council for Economic Advisors, Americans are paying hefty fees for conflicted advice. The study estimates an annual cost of $17 Billion in excess fees taken from retirement accounts due to high sales charges, hidden fees, and commissions on investments. And the $17 billion figure only applies to retirement accounts. It does not include the extra fees investors pay in other taxable accounts!
Saving for retirement is hard enough as it is without having to be on guard against unspoken conflicts of interest. So how can you ensure you’re getting the best possible investment advice? Get educated and ask the right questions. Before trusting someone with your money, the first question you need to ask is about the standard of advice you’ll receive. Ask your advisor:
“Do you advise under the fiduciary or suitability standard?”
We know, some definitions are in order. Financial jargon is confusing but it’s worth working through to protect yourself!
A Double Standard of Advice
A double standard has existed in investment advising for years. Some advisors, including Certified Financial Planners (“CFPs”) and Registered Investment Advisors (“RIAs”), are obligated legally and ethically to act in clients’ best interests. They must clearly spell out any conflicts of interest while advising on investment solutions. This is called the “fiduciary standard” and is the highest standard of care for financial advice. Hint: Fiduciary advice is what you want!
Broker-dealers are not held to the fiduciary standard, but operate under the “suitability standard”. A “suitable” investment abides by a lower standard and does not need to be in the best interest of the client. For example, while advising under the suitability standard an advisor takes into account the client’s risk tolerance and financial situation when picking an investment.
That’s a great start. But then the advisor can pass over lower cost investments for those with higher fees, such as mutual funds with a 5.5% sales charge (1) that kicks back a commission to the advisor.
The conflict of interests permitted by the suitability standard leads to commission checks for the broker and poorer returns for the investor. Worst of all, under the suitability standard a broker need not fully disclose the conflict of interests to the client. The client often thinks she is getting helpful and unbiased advice. That doesn’t sound suitable to us!
Fiduciary Standard: Fiduciaries are required to act impartially and provide advice that is in their clients’ best interests. A fiduciary must avoid misleading statements about fees and must avoid conflicts of interest. Fiduciaries are typically compensated by payment of a fee rather than a commission.
Suitability Standard: A broker-dealer is required under securities laws to judge the suitability of a product for a prospective investor, based primarily on that person’s financial goals, income, and age. The rules do not require a recommendation of the most cost-effective product, disclosure regarding conflicts of interest, or disclosure of the compensation received when making the recommendation.
The Fiduciary Rule
A rule passed last year through the Department of Labor was set to put an end to the double standard for retirement accounts (IRAs, Pensions, 401ks, etc.). Under the so-called “fiduciary rule” all investment advisors be held to the fiduciary standard when advising on retirement accounts. The rule was set to go into effect in April of this year, but recently the rule was set back by an executive order.
Enacting the fiduciary rule could mean billions of hard-earned dollars remaining in investment accounts to grow each year instead of being siphoned into the pockets of brokers and advisors. Over the long haul that difference could mean substantially more wealth in the accounts of retirees. More money means fewer working years before retiring, or a higher standard of living in retirement.
More than that, consumers could rest easier knowing that their brokers were legally obligated to do the right thing by abandoning commission-based conflicts of interest to put clients first. With the future of the fiduciary rule uncertain, the onus remains on individuals. Buyer beware.
Why We're Building BrightPlan
This sort of drama urges us to forge ahead with building BrightPlan. We believe everyone deserves fiduciary care across all their investment accounts. Consumers have paid too much for too little for too long. That is why we will always offer fiduciary care to our clients.
We believe a client-first approach is the right and only way to conduct business. As long as the suitability standard remains in place, being a fiduciary gives us an advantage. Even if the Department of Labor cannot pass the fiduciary rule, perhaps the market can fix the situation. More companies putting clients first may make “suitability” an unsuitable business model.
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