If Obama’s proposed changes are signed into law, we’re all going to be affected. On the surface, they sound good and in support of the average investor.
But what exactly are the changes? And how will they play out if approved and implemented in the financial services industry?
With more than $7 trillion in IRAs saved by 40 million American families (according to the White House in a report released Monday), this is a hot topic, to say the least.
What Are the Proposed Changes?
Obama is proposing new rules that would require advisers to put their clients’ interests ahead of their own personal gain. If accepted, the changes are expected to limit the amount of income earned by brokers and advisors off of their client’s portfolios or investments.
401(k) rollovers are one of the biggest concerns of the administration. If employers are offering diversified investments with lower fees than a similar portfolio with an advisor, why should you make the change? Many would argue that you shouldn’t.
Most people work with an advisor for peace of mind and because they don’t know what to do with the nest egg they have been accumulating for decades. Home purchases, sales and rolling over retirement plans are among the largest financial decisions someone makes in their lifetime.
Being a Fiduciary Versus Giving Suitable Advice
According to Bloomberg, right now, only some advisers are fiduciaries, required to put their clients’ needs first while many brokers and advisers need only to recommend “suitable” financial products.
A fiduciary is, “a person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets for the benefit of the other person rather than for his or her own profit.”
According to an Investment News article (released in 2009, the last time these concerns were raised by the Obama administration), It’s impossible for a broker to comply with this high fiduciary standard while simultaneously providing any type of investment advice that leads to income derived from those very recommendations.
When not acting as a fiduciary, an advisor isn’t required to act in the investor’s best interest. This perception isn’t in-line with the average investor’s idea of what a financial advisor is supposed to do to help them with their hard-earned (saved) nest egg. You go to an advisor for help making the best decisions for your future, right?
How Will They Affect Your Advisor?
It depends. If advisors are held to the strictest definition of what a fiduciary means (as stated above), they shouldn’t be earning commissions on recommended investments. Advisors might be pushed into a “fee only” model. I.e. instead of earning commissions, they’d just charge an investment advice or financial planning fee instead.
According to the Wall Street Journal, while the new rules don’t necessarily prohibit commissions, they are targeted at concerns that in some cases, commissions might be too big. The White House says the Labor Department proposal will define fiduciary in a way that doesn’t preclude getting paid through commissions. It sounds like a lot is still up for debate.
How Will They Affect You?
Stricter rules may remove an incentive for brokers and advisors to service accounts with smaller balances (less than $50,000 in many opinions). We’ve already seen some of these changes with larger brokerages, like Merrill Lynch.
Senator Tester was quoted saying that he was, “worried the proposal would have the effect of reducing options for small savers and could conflict with a similar effort now under way at the Securities and Exchange Commission, creating administrative headaches.”
You might have to choose between paying a large out of pocket fee to work with an advisor or not working with one at all. If they’re still earning commissions on your investments, just not to the same extent that they currently are, you may see a change in the service level or amount of time that they are willing to spend with you rebalancing your accounts.
I’m all about transparency. If that’s what these new regulations will help to put in place, that’s great. I think the best change that could happen is for advisors to talk more about fees in general and equate them with why an investment is suitable for their client.
The client should know what they’re paying, what they’re earning and be able to make their own decision if it’s appropriate. But if they don’t know that information in the first place, they won’t be able to decipher if what they’re paying for makes sense and if it’s competitive.
We know how much we’re paying when purchasing anything else, why shouldn’t it be that way with investments too? Don’t wait until the government makes changes on your behalf, find out what you’re paying today, what you’re earning in terms of return and how much risk you’re taking to get it.