Update on March 8th: Tony Robbins recently posted a video similarly emphasizing investor education on Investopedia.
Last Friday, US President Donald Trump signed an executive order which may halt the planned application of the “fiduciary rule” to large numbers of financial advisors and product providers to retirement plans. Opponents criticize this move as helping hide the high fees and selling motivations of many brokers and insurance agents, and supporters cheer the cutting of another potentially expensive regulation, but I’ll bet most readers are asking “what is the fiduciary rule?” and “is Trump’s killing of the fiduciary rule a good or bad thing for me?” In this post, I explain what the fiduciary rule is and how investors can best thrive without it.
A “fiduciary” professional is required to act in the best interest of the client, especially in putting the client’s interest ahead of his own interest, but also by disclosing and attempting to eliminate any conflicts of interest. In the US, registered investment advisors (like our firm) have long been held to a fiduciary standard, while many brokers, insurance agents, and bankers have traditionally not been fiduciaries. The “fiduciary rule” passed in 2016 was simply intended to hold these traditionally non-fiduciary professionals to a fiduciary standard whenever they served US retirement plans.
Rather, many brokerage and insurance professionals are held to a less strict “suitability” standard, which simply requires that any product they sell to a client be broadly suitable to the client while not necessarily being the one in the client’s best interest. The classic example is a broker who has the opportunity to sell one of two mutual funds to a client: if both are equally “suitable” to a client’s needs and risk situation, but one fund pays the higher commission, the suitability standard allows the broker to sell the higher-commission but suitable fund.
Whether a financial advisor is a fiduciary or not is often (but not always) related to their incentives and how the advisor gets paid (as I describe in the post “How Your Financial Advisor Gets Paid: One of the Most Important Questions to Ask“) :
- Financial advisors paid on commission have an incentive to sell what earns more commissions
- Professionals paid by the hour have an incentive to work more hours
- Managers who charge performance fees in theory have an incentive to perform, but can also have an incentive to take more risk
- Advisors who get paid an annual percentage of assets under management have an incentive to increase the amount of assets they manage, hopefully by good investment performance of the assets but also by providing better service and encouraging referrals
While the fiduciary rule may be meant to protect every day retirement savers from these high fees and conflicts of interest, in my experience, no rule or regulation will protect the customer as well as the customer simply being informed and educated about what they’re buying. No matter how much you regulate a brokerage firm or insurance company to act like a fiduciary, most will spend what they need to in order to comply with the letter of the rule but not the spirit of the rule. It is one of those statements so important it almost can’t be repeated enough: the best protection against non-fiduciary financial advisors is not a fiduciary rule, but an educated consumer. The most important regulations in financial services are those requiring full and fair disclosure, and strictly enforcing stiff penalties for false disclosure, but beyond that, it is critical for investors to demand more of their investment professionals directly.
In other industries, suitability rules can be seen here and there, but fiduciary standards are rare. A bartender may be required not to serve alcohol to anyone visibly intoxicated, but meeting that has the incentive to earn as many tips as possible. Car dealers often need to check that the buyer has a license to drive a car off the lot, but almost never check that a car best fits a buyer’s budget and rarely has an obligation to give the best price. Medicine may be the rare profession that has a Hippocratic oath to do no harm and care for the best interest of patients, but the question of how doctors are paid and what their incentives are is a topic for a whole other post…
Until next time,
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