Fiduciaries and Fees
The DOL Fiduciary Duty Rule has been the talk of the asset management industry for... quite some time now. This rule would require anyone who gives advice/manages money in a retirement type account be a fiduciary. A fiduciary is one who serves your best interest. If you are paying for advice or asset management, this makes sense. Your advisor works for you and places your interest above their own. In general, fiduciaries should be transparent about any conflicts of interest that they have and work to reduce those conflicts. When conflicts do arise, a fiduciary should put their client's interest above their own. Often, conflicts are seen when an advisor is paid by commissions on various products. Mutual funds often have multiple share classes, some pay large up front commissions to the salesperson and some have extra fees built in to compensate them over time. If your advisor stands to make more money recommending you one product over another, and both are appropriate for you, they are incentivized to recommend you the one that pays them more. Because of this clear and simple example of commission, a lot of the talk around the fiduciary Rule has been around cost. As the financial industry becomes more transparent and efficient, costs have come down for investors. Index funds have built up the expense, cutting momentum to a public battle in the pages of popular financial media. For the most part, this is a good thing! Reducing costs is one of the surest ways to boost returns. As I often say to clients, a dollar that you don't pay in expenses is a dollar that you keep in your account. In the context of the fiduciary rule, this focus on fees may be an oversimplification. Criticism of the rule from large brokerage houses like Morgan Stanley rightly pointed out that a fee based account might be more expensive in the long haul than a commission based account for someone who did not need to interact with their broker that often. While this is a little disingenuous (they could always lower the fee), they had a point if you were only talking about the dollars paid. The point is that the source of those fees brings about an inherent conflict. If you pay a fee to an advisor, they work for you. If they are being paid by a brokerage firm, they work for that brokerage firm. The amount matters less than the potential for conflict. Importantly, Fiduciary does not have to mean rock bottom fee! While yes, lower fees will generally be more in your best interest than higher fees, good advice and guidance can still cost money! A fiduciary should be paid in a way that does not bring a conflict of interest between you. That is the point. The pervasive focus on fees has everyone in a frenzy! In today's newsletter, Matt Levine asks what have we gained if the fiduciary rule doesn't lower fees.
If the fiduciary rule pushes investors from high-cost mutual funds recommended by commission-based advisers to medium-cost mutual funds recommended by expensive fee-based advisers -- and if investors' all-in costs aren't any lower -- then what have we gained?
While a broker being incentivized to put you in a higher fee version of the same mutual fund is a problem, it is not the most costly problem that the DOL rule can solve. Looking at client's outside accounts, I see cases all of the time where they could move to a lower cost fee structure to save a few basis points, or even reallocate to passive funds to drastically reduce costs and eliminate an active manager that isn't adding value. Those are not the egregious cases though. The biggest conflicts of interest that I see are in insurance products. Variable annuities are much more convoluted products than plain mutual funds in an investment account. Annuities are often attractive because the salesman can tout a guaranteed rate of return, or a promise that the product will never lose money! The conflicts are huge, however, when commissions approach 10%. I see products that are so convoluted I am almost certain that the salesperson did not understand what they were selling. They can focus on the bullet points in the pitch book that say GUARANTEE! and not dig any deeper. I have seen conflicts of interest lead to churn in accounts that cost clients dearly even if the returns of the actual investments were positive. I have seen products that purport to give S&P 500 linked returns with a guarantee of no losses deliver no returns in periods that the S&P 500 was up 50%. While many people in the financial industry are hard working, intelligent and hold themselves to high professional and ethical standards, many are not. If you have an advisor who may be good, but does not have the highest standards, and has a conflict of interest, you may well be getting very bad advice! It is not just the headline, or even underlying fees that you are charged, it is the whole body of advice and service you receive. You can pay no fee just by putting your money under your mattress, but that does not mean your mattress has a stronger fiduciary relationship to you than an excellent advice manager who charges above average fees for their service. Bad advice has no regard for your financial well being. Bad advice takes sales points that make a product seem appropriate and turn it into profit for the advisor and losses for the client. Good advice might cost money, but in the long run, will be MUCH less expensive than bad advice. While a fiduciary advisor will probably try to to lower your fees, that is not all they serve to do. They serve to give you excellent advice that will better your financial position. Eliminating conflicts of interest is not about eliminating a few basis points of fees. If you need good, personal advice, you will still need to pay for it. Working with a fiduciary is the best way to ensure that you will be getting advice that is truly in your best interest.