The future of the Department of Labor’s fiduciary rule is in jeopardy under the Trump administration. As of the writing of this article, its implementation has been delayed, but the rule could be changed or even scrapped. What happens remains to be seen.
In a way, however, that doesn’t matter because the rule — designed to tighten up the legal and ethical requirements for those giving retirement advice — has already let the cat out of the bag. It has shed light on how financial professionals are compensated and the different standards by which they operate. There’s no doubt that many in the financial industry are hoping it will go away, quickly and quietly and with its tail between its legs.
But even if the rule is eventually written off (or just rewritten), the debate already has brought a lot of attention to the industry’s confusing payment structure. Which is a good thing.
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Fees come to the forefront
A lot of investors look at their quarterly statements and, because they don’t see any fees being deducted, think they aren’t paying anything for the services they’re getting. That isn’t true, of course. All advisers have to be paid in some way. And the way they are paid determines their responsibility to their clients.
If the adviser is working for a brokerage firm, he or she gets a commission on the transactions they execute, and they are held to the suitability standard.
That means, for example, that if their client is looking for growth and is comfortable with a fair amount of risk, the broker will recommend a mutual fund that is “suited” to those conditions.
Will it be the best mutual fund for the client? Maybe. Is there a lower-cost mutual fund out there? Potentially. But under the suitability standard, there is no requirement for the broker to use the better or lower-cost mutual fund. It’s possible they will limit their choice to a fund family their firm wants them to use, and the client won’t even know there were alternatives.
The impetus for the fiduciary standard
The commission/suitability model is the oldest — and it worked pretty well for a long time. But then mutual fund companies started building in additional fees, and some started creating revenue-sharing agreements with brokerage firms. Often, consumers were paying more and getting fewer options. That was a big factor behind the DOL’s push to make the fiduciary standard a must for retirement advisers.
Under the fiduciary standard, advisers are required to put their clients’ best interests before their own needs or their firms’ needs. If the client wants a growth mutual fund, the adviser must pick the one they think is the absolute best fit and would have to be able to substantiate why — lower costs, higher returns or perhaps some other reason related to strategy or manager.
Those who are fee-only advisers will charge an hourly rate or a flat fee for their time. If they are fee-based, which is the most common approach for a fiduciary adviser, they will charge a fee based on a percentage of the amount of money in the portfolios they are directly managing. They do not receive a commission for the work they do.
The bottom line for investors
And that’s the important thing to remember when you’re choosing a financial professional: If you’re paying a commission, you’re not paying for advice — you’re paying someone to execute buy and sell orders for you. That person may be trying to do the best they can for their clients, but they can be stuck inside the rules of the broker-dealer they represent, and with a list of securities available to them that are profitable for the firm. In the fiduciary world, when you’re paying a fee, you’re paying someone to do the best thing for you, without an incentive to sell one product or another.
Because of the clamor both for and against the Department of Labor’s fiduciary rule, many people know more about this topic than their advisers ever expected they would.
No matter what happens from here, consumers should use that knowledge to choose the best adviser for their individual needs. Whether that adviser works in the suitability model or fiduciary model, at least the public can go in with eyes open.
Kim Franke-Folstad contributed to this article.
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