Much has been written about the new Department of Labor rule requiring most financial advisers be held to a “fiduciary” standard. Until the rule went into effect, a majority of financial advisers were legally held to a watered-down requirement requiring “suitability” of advice. Two questions come to mind:
- What is the difference between advice that meets the fiduciary standard and advice that’s merely suitable?
- How do I know if a fiduciary is truly acting as one?
The best way to explain the concepts is through examples. Frank is 65 years old, very conservative and concerned about stock market volatility. He owes $300,000 on his mortgage while paying interest at 4%. He has $400,000 in cash currently, $350,000 in an IRA account and wants to sell an older rental house for $300,000 with a potential income tax on the sale of $50,000.
A Broker/Dealer’s ‘Suitable’ Advice
First Frank seeks the advice of a broker held to the suitability standard. Sarah works for a very large national company based on Wall Street. She knows if she tells Frank to pay off his mortgage, she will lose potential business, and potentially her job. You see, since she is held only to a suitability standard, she owes her primary allegiance to the company she represents, not to the investor.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Instead of recommending that Frank pay off his mortgage, she instead brings out graphs showing how the stock and bond market has performed historically in an attempt to convince this person how investing in the market will be better than paying off a mortgage in retirement. In the end, a lot of pressure is applied for Frank to invest the cash, the IRA and the rental property proceeds net of tax into stocks and bonds. Sarah would invest the $1 million into loaded mutual funds where Frank is charged $57,500 in commissions on the first day.
Fiduciary Advice from 2 RIAs with 2 Different Opinions
Next, Frank seeks the advice of two different Registered Investment Advisers (RIA) held to the fiduciary standard. The first RIA suggests the same advice he heard from Sarah, but would invest in no-load funds so that Frank can avoid paying the commission. The second RIA suggests paying off the mortgage, and investing the rest into stocks and bonds. In each of the three meetings, Frank brought up the fear of rising interest rates and questioned whether bonds were the best investment solution. Each adviser responded similarly, citing long-term historical bond performance statistics.
Do RIAs held to the same standard sometimes offer completely different advice? The answer to this question is absolutely yes. This fiduciary standard of care isn’t always consistently applied. One problem with this standard is that if you sell stocks and bonds for a living, you may be convinced everyone needs stocks and bonds. If you sell annuities and not stocks, you may tell the world about how horribly volatile the stock market is and talk them out of investing in stocks and bonds.
A Final Piece of Fiduciary Advice with a Different Take
What might a better fiduciary solution look like here? Frank sought out the advice of an RIA who was also a CPA. The first piece of advice was to pay off that mortgage. The second piece was to get a home equity line of credit in case of a liquidity emergency. As for the rental house, instead of paying the income tax on the sale, a tax-deferred 1031 exchange was decided upon, reinvesting into a professionally managed apartment complex. Finally, a mix of stocks and a fixed indexed annuity was recommended as a bond substitute.
Frank saved on income taxes, improved cash flow, and has better growth potential without significantly adding to overall portfolio risk.
The Final Word: My Take on the Fiduciary Rule
I’m generally happy about the new DOL rule and its attempt to raise the bar within my industry. However, I don’t think the new rule goes far enough. How can an adviser truly offer the best advice if they aren’t licensed in — and fully understand — stocks, bonds, passive real estate, insurance products and federal tax law implications?
In the end, financial planning advice is based on the opinion of your adviser. Opinions vary between advisers based upon what they are familiar with, their licensing and experience. Opinions cannot be easily measured or compared.
So, even with a new set of standards within the industry, it’s still up to the consumer to perform their own due diligence when selecting the best financial adviser for themselves.
-
Investing Freebies: Perks You Get for Owning These StocksWhile the biggest investing returns come over the long term, these companies offer instant gratification for investors with several freebies and perks.
-
Choose a Beneficiary for Your Estate Plan: It's Not 'Duck, Duck, Goose'Choosing a beneficiary for your 401(k), insurance policy or similar assets is crucial for estate planning. Here is how to do it, and six pitfalls to avoid.
-
How an Expired Passport Thwarted Blackmail (and What Other Important Documents You Should Keep)An optometrist produced his expired passport to foil a blackmail attempt by the daughter of a former employee. After proving he was out of the country on the date of a forged diary entry, he took it a step further.
-
Optimize, Grow, Retain: The Power of Annual Client ReviewsFinancial advisers can use annual reviews to help enhance client outcomes, strengthen relationships and build their practice.
-
I'm a Real Estate Investing Pro: This Is What Investors Should Know About Truck Stop InvestmentsTruck stops might seem like good investments, but they can actually be a risky gamble due to unstable fuel prices, unreliable operators and coming changes in transportation. Instead, consider safer options like industrial or residential properties.
-
Don't Disinherit Your Grandchildren: The Hidden Risks of Retirement Account Beneficiary FormsStandard retirement account beneficiary forms may not be flexible enough to ensure your money passes to family members according to your wishes. Naming a trust as the contingent beneficiary can help avoid these issues. Here's how.
-
This Is How Life Insurance Can Fund Your Dreams NowBeyond a death benefit, life insurance can provide significant financial value and flexibility through 'living benefits' while you are still alive, helping with expenses like education, business ventures or retirement.
-
Potential Trouble for Retirees: A Wealth Adviser's Guide to the OBBB's Impact on RetirementWhile some provisions might help, others could push you into a higher tax bracket and raise your costs. Be strategic about Roth conversions, charitable donations, estate tax plans and health care expenditures.
-
One Small Step for Your Money, One Giant Leap for RetirementSaving enough for retirement can sound as daunting as walking on the moon. But what would your future look like if you took one small step toward it this year?
-
This Is What You Really Need to Know About Medicare, From a Financial ExpertHealth care costs are a significant retirement expense, and Medicare offers essential but complex coverage that requires careful planning. Here's how to navigate Medicare's various parts, enrollment periods and income-based costs.
