You know who has your financial best interests at heart? We’re guessing that “Wall Street” is not the first answer that comes to mind.
Sure, there are plenty of good eggs in the financial services industry — money pros truly committed to delivering unbiased financial advice to help consumers achieve their life goals. And to them we say “thank you,” because there aren’t a lot of legal or financially rewarding reasons for them to do so.
That’s all changing thanks to a new rule from the Labor Department, which puts new regulations on advisors who have their hands in your retirement accounts. The media has been all aflutter about this. (Wall Street greed vs. unsuspecting Main Street is headline gold.)
But what does it all mean for you — the consumer, investor, IRA saver, 401(k) contributor? Here’s our guide to walk you through the new rule.
What’s this thing all about, anyway?
This fiduciary rule requires financial advisors and brokers who provide advice for retirement accounts to act in the best interest of their clients.
This is the kind of rule that you would hope wouldn’t be needed — kind of like not driving at highway speeds with a kid on the fender of your car — but, well, it is.
As we said, there are plenty of good advisors out there who already follow this rule. But there are also plenty who don’t, and this is the Labor Department’s attempt to protect investors from those bad apples. (For your light reading pleasure, here are all the details on the fiduciary standard rule — aka the Conflict of Interest Rule.)
Fiduciary … what?
Fiduciary is a fancy term for advisors who don’t put their own profits over the needs of clients. If you’re a fiduciary, you’re held to a fiduciary standard, which means the same thing.
Under this rule, advisors and brokers who provide investment advice for retirement accounts must now be fiduciaries. (Here’s a good rundown on what financial titles mean.)
What problem is this new rule addressing?
Currently, many advisors and brokers are subject only to a “suitability standard”: If an investment is deemed a good fit for your needs, an advisor can put you in it.
As you might imagine, there are plenty of investments that might be loosely defined as a “good fit.” Unscrupulous brokers could choose the ones that would line their pockets with the highest commission. No more, once the new regulations go into effect.
When does it take effect?
Many of the basic regulations — the best interest standard — will go into effect in April 2017; others won’t be implemented until 2018. There’s also a chance of a court challenge.
What’s considered a ‘retirement account’ under this rule?
Are you saying that I’ve been getting bad — or at least biased — investment advice?
While we haven’t had the pleasure of meeting or evaluating the financial pros on your payroll, we can say that the system in which they operate has long favored those giving the advice over those receiving it.
When a person’s take-home pay is tied to bonuses and commissions — and those financial rewards are based on selling the products that make the company more money (versus recommendations that make the client the most money) — salesmanship, not stewardship, is rewarded.
That said, not everyone in the industry is just looking out for No. 1. And the SEC’s “suitability standard” has (hopefully) cut down on the number of 90-year-olds put in high-risk, small-cap mutual funds. But binding an advisor to recommend products that are “suitable” is a pretty low bar and doesn’t exactly scream “customer first.”
After all, a broadly diversified mutual fund with a 1.2% sales charge may be perfectly suitable for a particular client. But isn’t a mutual fund that has the exact same investment objective and risk profile with a 0.2% expense ratio “more suitable”? That’s the conflict that the new fiduciary rule seeks to clear up.
What are the exceptions?
The new rule says that a fiduciary cannot accept payments that create conflicts of interest. Fine. But the Labor Department has offered an exception that many brokers are likely to latch on to: Firms can continue to accept the types of compensation they do now (notably commissions and revenue shares) as long as they commit to a “best interest contract” exemption called a BIC.
The BIC still requires firms and advisors to act in a client’s best interest — are you getting tired of that phrase yet? — and requires that they disclose (on their websites) what amounts to every minute detail of how they are paid.
And the rule says education doesn’t constitute advice, unless a specific recommendation is made. There was some concern that advisors would have to push a paper across the table to be signed before even talking to a prospective client; that’s not so.
This sounds great! Why would anyone oppose this?
How much time do you have? The Labor Department received 3,134 comments over a five-month period about this thing. You’d probably oppose it if you were an advisor who’s been making a pretty good living off “suitable” investments.
But is there a downside for consumers?
You know how airlines tack on fees like bite-sized, individually packaged pretzel snacks? As it tends to go in situations like this, some costs will probably be passed along to the little guy. That means some advisors will raise their fees to account for money lost due to the regulation.
Even if you don’t work with an advisor now, there’s a chance you might want to work with one in the future. Assuming you haven’t swiftly accumulated millions between now and then, the rule may make that harder. As more advisors shift toward a fee-based compensation program, there is concern that they won’t want to deal with small accounts.
On the other hand, it could save retirement investors money, says Kyle Ramsay, NerdWallet’s investing manager. “This ruling should better align the interests of investors with those providing advice, which would potentially result in better returns and lower fees.”
I don’t have an advisor, so I won’t be affected, right?
You still might see more paperwork. For example, part of the regulation is an attempt to protect investors as they roll a 401(k) into an IRA when leaving a job. Brokers may not be able to suggest you do that without first signing a BIC.
Does everyone in the financial services industry lack a moral compass?
Have you seen “The Wolf of Wall Street”? Just kidding. That’s not a fair way to characterize the entire industry. Still, working in the financial services field can put a strain on the moral fiber of even the most upstanding citizen.
If you were paid more for putting clients into a certain product that earns your company (or you directly) more money than other nearly identical choices that cost your clients less (even just slightly less money) but made you and your firm bupkis, what would you do?
Of course, there are some people who sleep just fine knowing the advice they give is “not bad, per se” or at least “better than what John down the hall is getting his clients into.” But there’s a giant gray area that exists between “good for the client” and “good enough.”
Ultimately, who’s the ‘winner’ with this rule?
Consumers, of course. And some advisors, too. Within the investment industry, advisors who are already fiduciaries are pretty happy with this rule. That includes human advisors, but also robo-advisors — companies that use computers to manage client investment portfolios.
“Online advisors like Betterment and Wealthfront will be attractive options for investors, as automation and software enable them to help smaller accounts with less overhead and thus lower fees,” Ramsay says. “They are already regulated by the SEC and abide by the fiduciary standard.”
Bottom line: No one has your best interests at heart more than you. So no matter what the rules passed, forms signed, oaths taken, it’s on you to do your due diligence — checking up on a financial firm or an advisor’s track record and credentials — before entrusting your money to anyone.
This article first appeared in NerdWallet.