Trump Order is Bad News for Retirement Savers

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On February 3, President Trump issued a memorandum to the Secretary of Labor regarding the “Fiduciary Duty Rule” that was scheduled to go into effect this April. Suggesting that the rule “may not be consistent with the policies of my Administration,” he directed the Department of Labor to reexamine the proposed rule and consider rescinding or revising it.

The Department of Labor has been working on this rule since 2009 with the aim of improving the quality of investment advice received by investors in retirement plans. With traditional pensions on the decline and participant-directed retirement plans like 401(k)s and IRAs replacing them, more people need investing advice than ever. This has highlighted a problem described in a Department factsheet:

Many investment professionals, consultants, brokers, insurance agents and other advisers operate within compensation structures that are misaligned with their customers’ interests and often create strong incentives to steer customers into particular investment products. These conflicts of interest do not always have to be disclosed and advisers have limited liability under federal pension law for any harms resulting from the advice they provide to plan sponsors and retirement investors. These harms include the loss of billions of dollars a year for retirement investors in the form of eroded plan and IRA investment results….

To put it bluntly, too many so-called advisors recommend the products that earn them big commissions, not the ones that offer the best value for the investor. When we buy a car, we understand that the dealer is just a salesperson who would love to sell us the most expensive car, whether we need it or not. When we go to a doctor, we expect the recommended treatment to be in our best interest, not what is most profitable for the doctor. The question is what is the appropriate standard of care when we depend on an advisor’s expertise for our financial health.

The proposed Fiduciary Duty Rule would require all those who provide retirement plan advice for compensation to adhere to a fiduciary standard, which requires “putting their clients’ best interest before their own profits.” This requirement would apply whenever advisors recommend an investment, if they are compensated in any way for doing so. It doesn’t matter whether the client is paying for the advice itself or whether a sales rep is earning a commission for selling a product.

Closing a loophole in the fiduciary standard

Debate over the fiduciary standard goes back a long way. I have discussed it before, especially in Section 11 of my “Sound Investment” series and in my review of Helaine Olen’s Pound Foolish, a critique of the personal finance industry.

Many people may not realize that the fiduciary standard is already well established in law. The Investment Advisers Act of 1940 required anyone giving investment advice for compensation to register as such and adhere to such a standard. So what’s the problem? The Securities and Exchange Commission made an exception for those whose primary business is trading securities, even if they also give some advice to their customers. In recent years, brokers and other sellers of financial products have expanded their financial advising functions and often receive compensation for them. Nevertheless, the SEC continued to maintain that they did not have to register as investment advisors nor adhere to a fiduciary standard because their advice was “incidental” to their job as brokers. So two types of advisors, those obligated to put their clients’ interests first and those without such obligation, have co-existed in the financial services industry, with the general public often unable to tell the difference. Brokers and insurance agents have been able to call themselves financial advisors, without being obligated to recommend the products that are best for their customers.

After the Great Recession, the Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) gave the SEC the authority to reexamine the issue and write a new regulation. After studying the matter, the SEC concluded that the loophole it previously created should now be closed: “The standard of conduct for all brokers, dealers and investment advisors, when providing personalized investment advice about securities to retail customers…shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer or investment advisor providing the advice.” The actual regulations that will implement this principle continue to be hotly contested. Meanwhile, the Department of Labor has finalized a fiduciary rule based on a different statutory authority, its authority to regulate retirement plans under the Employee Retirement Income Security Act of 1974 (ERISA). The DOL’s rule would apply only to financial advice relating to retirement plans, not to investments more generally. This is the rule whose implementation the President is now blocking.

Last month, the Consumer Federation of America issued a report, “Financial Advisor or Investment Salesperson?: Brokers and Insurers Want to Have it Both Ways.” The report documented the two-faced way that “transaction-based financial professionals” describe themselves:

When they are marketing their services to the investing public and enticing clients into handing over their hard-earned savings, these sales-based financial professionals present themselves as “trusted advisors” whose only concern is their clients’ best interest. But try to hold them legally accountable for meeting that standard, and those same “advisors” quickly change their tune. Because they are salespeople who are “merely selling” investment products, they claim, no fiduciary standard ought to apply.

In their marketing materials, brokers and insurance companies use terms like “financial advisor,” “financial consultant,” or “retirement counselor” to describe themselves. They characterize their services as “a comprehensive approach to total wealth management delivered by your most trusted advisor,” and claim to be “safeguarding the money of others as if it were our own,” to quote some of their websites. Surveys show that this kind of marketing is successful in getting the general public to confuse sales reps with the registered investment advisors who actually are held to a fiduciary standard. But when they are fighting that standard in legislative hearings or in court, they are quick to claim that they are just salespersons. They deny having the special relationship of trust that would justify classifying them as fiduciaries under existing or proposed law.

The high financial stakes

The Consumer Federation described how savers are being hurt by this situation:

Investors who unknowingly rely on biased salespeople as if they were trusted advisors can suffer real financial harm as a result. It is estimated, for example, that retirement savers lose $17 billion a year or more as the result of the excess costs associated just with conflicted retirement advice. The cost on an individual basis, in the form of lost retirement savings, can amount to tens or even hundreds of thousands of dollars over a lifetime of investing, money that retirees struggling to make ends meet can ill afford to do without.

Here’s a hypothetical example. Suppose you save $500 a month for 20 years in a tax-deferred retirement plan holding mutual funds, for a total investment of $120,000. With a 7% annual return after expenses, you would accumulate $260,463 over the 20 years. However, if you lost $25 of each $500 invested because of unnecessary commissions or fees, and then received only a 6% return because of higher annual mutual fund expenses, you would accumulate only $219,469, a shortfall of about $40,000. Multiply this by millions of savers and you begin to see the size of the problem.

Of course, every company that charges high fees, commissions or expense ratios will try to justify them as fair compensation for value provided. So the question is whether investors who are being charged more are receiving any added value. Although investment returns can be all over the map, most of the evidence does not support the contention that the investment products pushed by brokers and insurance reps outperform investments that are available less expensively elsewhere. In particular, index funds that you can buy directly from companies like Vanguard and Fidelity with no sales commissions and rock-bottom expense ratios outperform the majority of high-cost actively managed mutual funds. For more explanation of why so many aggressively marketed investments have such disappointing returns, see Section 6 of my “Sound Investing” series.

When I worked as a registered investment adviser (the kind who was legally bound by the fiduciary standard), many clients came to me for a portfolio review. Using standard measures of costs and risk-adjusted performance, I routinely found overpriced, underperforming, and often unnecessarily confusing products that had been recommended to them by brokers or insurance agents. In most cases, they would have accumulated more if they had gotten simpler and better advice.

What we see here is a massive and unearned transfer of wealth from middle-class savers to financial service companies that too often serve themselves at the expense of their customers. This is one reason why the era of self-directed retirement accounts has also been an era of increasing inequality in the distribution of wealth. The new regulations are intended to give middle-class savers a fighting chance.

Alleged adverse effects of the fiduciary rule

Businesses that oppose consumer protection initiatives rarely admit what really concerns them, that a new rule may interfere with a profitable business model. They almost always claim that it will hurt consumers in some way that consumer advocates and regulators fail to see.  President Trump’s order takes a pro-consumer stance by asking the Department of Labor to examine whether the fiduciary rule would “adversely affect the ability of Americans to gain access to retirement information and financial advice.” The implication is that retirement savers may be losing something if they cannot get the “free” advice offered by brokers and insurance agents, even if that advice is flawed by conflicts of interest that work against investors’ best interests.

Investors of modest means do need financial advice that doesn’t cost them much, and accepting the recommendations of sales reps is one way to get it. Investment advisors who do not make their money from sales commissions derive their income from flat fees for advising sessions or for writing financial plans, as I did, or from asset management fees based on a percentage of assets under management. Making a living while keeping these charges affordable for small investors is not easy. It is one thing to set a fiduciary standard, but another thing to make fiduciaries available at a price most savers can afford.

However, the fiduciary rule need not leave most retirement savers with no affordable advice at all. The kind of basic advice that small investors need to handle their retirement plans is already pretty widely available, and could be even more available if employers and schools made more of an effort to provide it. Most savers will do fine putting the bulk of their retirement savings in a single “target retirement fund,” or in a small number of index funds covering domestic and foreign stocks and bonds. (Of course, they need to follow other basic advice like getting an early start and saving 10-15% of income.) Financial professionals can still make a good living selling advice to people of means who are interested in playing riskier or more sophisticated investment games. But for the average worker, the present system relies too heavily on a business model that institutionalizes conflicts of interest and needlessly skims off too large a portion of the savings that people need for their retirement.

President Trump’s order is an anti-consumer measure shrouded in pro-consumer rhetoric. It purports to protect American savers, while really protecting businesses that charge them too much and deliver too little. It ignores years of research by the federal government’s own agencies as well as by professional financial planners, academics and consumer groups. It shows that the people who have Trump’s ear are the billionaires and bankers he has brought into his administration, not advocates for the general public. It is one more piece of evidence that–populist rhetoric notwithstanding– he intends to serve the economic elites rather than the people.

 

 

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