New Fiduciary Ruling
This week the Department of Labor (DOL) issued a landmark new ruling that will raise investment advice standards for retirement accounts. By January 1, 2018, all financial advisors will be held to a fiduciary standard. All advisors will have to do what is in the best interest of their clients. However, brokers will still be held to a suitability standard for taxable accounts.
The final rule that was released was watered down after lobbyists prevailed on a number of key points. Brokers can still sell their own proprietary funds and charge a commission, if their client signs a waiver. Even though the new ruling is not perfect, it is a step in the right direction.
As a Registered Investment Advisor (RIA), I’m already a fiduciary for my clients. I chose to be an independent advisor because I wanted to give advice that was in the best interest of my clients. The only way to do this was, by minimizing conflicts of interest and not selling products. If I chose the career as a broker, I would only be held to a suitability standard. This means that I could sell products and services if they were “suitable” to the client. As a fiduciary, my interests are aligned with my clients.
So why is this new “fiduciary” rule so important for consumers?
The new rule will lower costs for advice and limit commissionable product sales. The best way to explain the difference between these standards is through a real example. To protect the identify of this individual, I will refer to him as “Maxx”, after my son.
I met with Maxx at my office just last week. He had lost his job 1 year ago. Maxx met with his broker to take control of his dire financial condition. Maxx had been invested in a Fidelity 401k plan and had saved around $150,000 for retirement. This “broker” advised Maxx to rollover his 401k into an IRA. On the surface, this is not bad advice. However, Maxx purchased an “A” share mutual fund and paid a 4.7% front–end sales charge. Not only did Maxx pay the commission, he moved from his Fidelity fund into another fund with a higher expense. To make matters worse, the funds he bought were a proprietary mutual fund sold by the broker. The funds that he purchased were clearly inferior to that of the Fidelity funds. The Fidelity funds ranked higher in each of the respective categories. The DOL issued this fiduciary ruling to put an end to this abuse. This was a textbook example of the importance of the DOL ruling for consumers.
What will be the biggest impacts of this ruling?
The new rule will ultimately lower expenses on all mutual funds. More advisors will sell low expense exchange-traded funds (ETFs). Mutual funds with poor results will be under pressure if they continue to lag. The big winners will be low cost fund families such as Vanguard and Fidelity. ETF companies and robo-advisors will also benefit. I expect even more companies to begin to offer their own robo-advisor platforms. There is the “dark side” to this ruling. Many portfolios will be moved into a black-box asset allocation model. These brokers leverage technology to over-diversify their clients’ portfolios. They simplify risk and misjudge valuations. In my estimation, it was bad financial modeling that helped pave the way to the Great Recession in 2008. Those same flawed models based on antiquated statistics are now being applied by these robo-advisor platforms. If a robo-advisor is using standard deviation to calculate investment risk, it is gauging a statistic with many flaws. I believe those financial advisors that are actively managing market risks, properly judging values, and showing investment acumen will be the true fiduciaries for their clients.
If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.
Please read our disclosure statement regarding the contents of this post and our website as a whole.
Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.
