Fasten your Financial-Lingo Safety Belts, folks, because we’re going to be wading hip-deep in technical terms this week, including repeated use of the word, “fiduciary.”
Wait — come back here!
This is serious business, and could means the difference between spending your eventual retirement in a sunny Florida condo vs. a reconditioned shipping container. The crux of the matter is how much of your eventual nest egg gets lost to brokers and salespeople in overpriced fees and commissions and how much stays in your nest. The topic is getting attention after President Obama endorsed a new Labor Department rule last week that will tighten the rules on financial advisers by requiring them to adopt a fiduciary standard.
And yes, I know what you’re thinking, but a fiduciary is not a type of camel. You are thinking of a dromedary.
Suits and suitability
A fiduciary is a financial adviser who is legally bound to put your interests first and foremost in making recommendations about how to invest your money. If you think this sounds like a good idea, you are not alone. Also, if you think this is how all financial advice is dispensed, you are sadly deluded.
Only about 10 percent of financial advisers adhere to a fiduciary standard, with most of the rest operating under what’s called the “suitability standard.” This means only that they recommend stocks, bonds or mutual funds that are suitable for your financial situation and goals. That sounds reasonable but, as Obama pointed out, because the suitability standard doesn’t address how a broker is compensated it results in advice that can be “conflicted.”
Example: You go to a car broker and say you want a vehicle for a family of four. On his lot, the broker has a minivan, an SUV, a quad-cab pickup and a surplus German Army Mungo ESK transport. Under the fiduciary standard, the broker sells you the most fuel-efficient vehicle with the best mileage, lowest dealer markup, highest crash-rating and lowest annual operating cost.
That’s too bad for your broker because, since demand for light infantry vehicles is slow, he’d get a bonus if you took the Mungo. Under the suitability standard, however, your car just has to be “suitable” for your needs and the broker doesn’t have to put your interest before his. And that is how you end up driving the most heavily armored vehicle in the Cub Scout car pool.
In the same vein, there’s nothing to stop a broker from putting you into a “suitable” mutual stock fund that pays him a fat commission, while ignoring the fact that the annual fee is excessively high and will milk your retirement account for years to come. Which isn’t to say that every broker, or even most, act that way. But if they don’t, why does the White House find that the lower standard costs Americans $17 billion in losses every year? And why are all the big financial service firms screaming that a fiduciary standard means the end of anyone ever getting “free” advice from a broker?
Consumers aren’t dumb enough to believe they get anything from a big bank or brokerage house for free — and the ones who do believe that really need the protection of a fiduciary standard. Paying an upfront fee for non-conflicted advice is something investors can understand. Or they can choose to pay commissions — as long as they’re disclosed. And while we haven’t seen the final rule that the Department of Labor will propose, I’m betting it will allow anyone who wants to overpay instead of shopping around to do so quite freely.
As this debate proceeds, ask any broker who gripes about the proposed rule this: “If not mine, whose interests do you put first?” If all you get is a bunch of blather about the fiduciary standard limiting American workers’ access to financial guidance or pricing them out of professional retirement planning, stop to consider just how likely it is that the financial services industry will suddenly turn its back on a $1.7 trillion-a-year market.
Not very. And any argument to the contrary contains a hole so big you could drive a Mungo ESK through it.
Brian O’Connor is author of the award-winning book, “The $1,000 Challenge: How One Family Slashed Its Budget Without Moving Under a Bridge or Living on Government Cheese.”