On February 3rd of this year, President Trump ordered the Department of Labor to delay and review the Fiduciary Rule. The regulation, enacted by President Obama last year, was set to go into effect on April 10, 2017, but now faces delay for six months. This delay is being widely interpreted as an attempt by the Trump administration to get rid of the regulation before it begins.
The Fiduciary Rule would force all financial professionals who work with retirement plans and provide retirement advice to act as fiduciaries. A fiduciary is someone who is bound legally to operate and advise solely in the client’s best interest. The logic of a financial advisor operating in his or her client’s best interest seems intuitive, but that is often not the case, which is why this rule needs to go into effect and stay in effect.
The main opponent of the Fiduciary Rule is the financial services industry, which argues, among other things, that it would take away options from consumers. In an interview with the Wall Street Journal, newly appointed White House Economic Director and Former President and CEO of Goldman Sachs, Gary Cohn, offered this argument against the rule.
“We think it is a bad rule. It is bad for consumers… This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger.”
This is a false equivalency if I have ever heard one. There are many different ways to invest in the market with varying levels of risk and reward, but retirement planning is the broccoli of investing. So how would you feel if your waiter put a steak on the menu, told you it was broccoli, and said it was a heart-healthy meal? Oh, and I almost forgot to mention: how would you feel if that waiter got a fee from the steak company for getting you to sign up for that 20 oz porterhouse?
See, here’s the thing: at it’s core, retirement planning should be about low-risk returns where you keep as much of that return as possible. Anything else is, quite frankly, a distraction. A financial advisor can easily offer you distractions by steering you away from index funds and similar investment strategies towards actively managed funds that charge higher fees and, more often than not, do not beat the market. Financial professionals often do this because firms will offer payment incentives for directing an investor towards the fund. The ethics of this system are shaky at best, and while not all unbound advisors act in this manner, it is clearly more than just a small part of the financial services industry, and that’s why consumers need protection in the form of government regulation.
As I mentioned earlier though, this is not the only major argument against the fiduciary rule. The financial services industry has also argued that the rule will raise costs for the average consumer as the cost of lost incentive fees will be passed onto the consumer in the form of more flat fees being charged for advice.
It’s true that the rule would lead to more fees for advice, but consumers will still more than likely save money if they get advice for their best interest and follow that advice. The fees of actively managed funds are often high enough to take away substantial amounts from an investor. Morningstar reported that in 2013 the average mutual fund charged 1.25% annually. That may seem low, but compare that to the Vanguard 500 Index Fund’s annual fee of 0.16%, and you see the difference. Compound interest over the typical length of a retirement investment and that’s a difference of thousands of dollars lost to fees. Fund managers know this too. In it’s report on 2015 expense ratios, Morningstar stated that investors are paying less for fund management and attributed it to lower reliance on actively managed funds.
“The trend is being driven more by investors seeking low-cost funds than it is by fund companies cutting fees. Fund investors are increasingly buying passive funds and investing in lower-cost actively managed funds,” said the Morningstar Report. Despite fund managers taking and benefiting from this strategy, it would seem the average investor has yet to benefit .
“However, much of the increased economies of scale are going to the fund industry rather than investors. Assets under management have risen faster than fees have fallen,” said the same report.
Actively managed funds have been a major part of the financial services industry for decades now, and incentive fees for bringing investors into a fund are a major part of what keeps new money coming in. Main street hasn’t quite picked up the general truth about these funds the same way industry insiders have, but the shortening of that gap will likely come in time. That fact places even more importance on advisors bringing consumers into mutual funds. Like I said, many advisors are free to participate in this practice but don’t. However, clearly many advisors do participate in this practice. As actively managed funds begin to lose consumer confidence, they’ll probably face even more pressure to participate.
I for one wouldn’t count on a Quixotic industry insider to come charging to our collective rescue anytime soon; that’s what government regulation is for, and the Fiduciary Rule is just the type of regulation needed to protect consumers in this case.