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What investors should know about the Department of Labor Fiduciary Rule

This rule has been hotly debated over the past several months and although it can impact many individuals, many individual investors don’t seem to care or want to know the details. Frankly, that is understandable as so much in the financial sector is a bit ‘cloudy’ shall we say.
With that in mind I thought it may be helpful to give you a clear summary of the major benefits and discuss a couple concerns.
• The first thing an investor needs to understand is the difference between a broker and a registered investment advisor (RIA). As an investment advisor we are held to a higher standard of operations than a broker in dealing with a client’s account. How so?
o First as an RIA we are required to put the client’s best interest ahead of ours. I know it seems hard to believe that a financial advisor would not have to do that, but sadly it’s true. Registered investment advisers are "fiduciaries." In that way, they're more like doctors or lawyers — obligated to put their clients' interests even ahead of their own. That means disclosing fees, commissions, potential conflicts and any disciplinary actions they have faced. As a fee-only advisor we don’t earn any commissions on any purchases or sales nor do we have any conflicts of interest. Simply put, we work with a client to determine a risk profile, overall investment objectives and then we put ourselves in our client’s shoes and invest the money as we would if this was our own personal funds. Do for our clients what we would do for ourselves.
o This is not the case when it comes to the broker side of the business. In fact, the difference between a broker and an RIA is significant though most people don’t realize it. Brokers buy and sell securities and other financial products on behalf of their clients. They also can provide financial advice, with one key stipulation: They must recommend only investments that are "suitable" for a client based on his or her age, finances and risk tolerance. So, for example, they can’t pitch penny stocks or real estate investment trusts to an 85-year-old woman living on a pension. But brokers can and often do push clients toward a mutual fund or variable annuity that pays the broker a higher commission than other equally suitable products — even without disclosing that conflict of interest to the client. For example, we regularly see clients that invest in an annuity inside of an IRA or 401-k plan. I will never understand why this would be done to a client. The two main benefits of an annuity are tax deferment and a guaranteed stream of income upon withdrawal. An IRA or 401-k is already tax deferred so that benefit is no benefit at all. Secondly, the insurance companies who sell annuities guarantee a certain stream in the future. Though investing in individual stocks and bonds doesn’t come with the same ‘guarantee’ it is extremely likely that an advisor investing your assets appropriately will be able to provide an equal or greater stream of cash flows once needed. Annuities are products designed to generate a profit for the insurance company so their projections and guarantees are very conservative. In other words, they know with near certainty that they will earn more than enough to guarantee your stream of flows in the future. So why do brokers do this? Money in their pockets. The broker collects 5% to 7% of the deposits made in an annuity for the first two years. Good for him or her, but very costly for you.
With these stark fundamental differences now clearly defined, we can turn our discussion toward the specific Department of Labor (DOL) rule and how that will impact you. First, let me say that generally I am not for regulations. Market forces in most cases should take care of any anomalies that may occur. That is when information is clearly disseminated. In this case, I think it is needed though as most investors don’t even understand the basic differences discussed above between a registered investment advisor and a broker.
• First, any of our clients or anyone else dealing with a fee-only RIA will not notice any changes as we have already been meeting or exceeding these new fiduciary requirements.
• Those of you working with a broker or commission based advisor should see some significant improvements. First, you will likely be moved to a fee-based approach as the costs of the products you have been sold in the past will be tough to justify under the new guidelines.
• The advice you are given should now be what’s best for you not what is most profitable to the broker.
Of course there is always the other side when it comes to regulations…
• The primary complaint I hear is that small investment accounts will be neglected because the fees earned will be limited in comparison to selling the client a product. I for one discount this issue. First of all there are already many advisors that place minimums on their clients. In other words if a client doesn’t have $250,000, $500,000 or even in some case $1,000,000+ then the company won’t manage the client’s account. That being said there are numerous firms like ours that don’t have minimums and yet somehow are able to thrive. We take the approach that everyone needs guidance and if we can add value to the process of accumulating wealth and securing a solid financial future then we want to be a part of it. If we do our job in tandem with the client’s commitment to financial security then the client won’t be ‘too small’ forever!
• One area that I am concerned about is greater government intervention. Let’s face it the Social Security system is a failure. Yes, it allows many people a steady stream of income, but if that same 15.3% of their pay (7.65% taxes withheld plus company 7.65% match) was invested in a private account in even conservative investments over the life of the working individual people would have accumulated significantly more than they get from the system today. Likewise, they would not only be able to draw similar levels of money during retirement, but would likely have a tidy sum left to pass to heirs in the future. The social security system returns on your money are only about 1% and when you die there is nothing left. The current administration has designed a new IRA type account, the myRA, which is similar to a savings bond approach. The concern here is that over time the government will expand its reach and require deposits under a certain level to be in government bonds, etc. At this point is probably more conspiracy theory, but the general skepticism is not unwarranted. The Social security program was originally designed to be kept separate from the everyday operating budget, but then when the money was just too tempting they combined it and issued treasury bonds in place of the money in the Social Security trust fund. Initially it passed scrutiny, but now years later as the US is burdened by debt from overspending the security of the funds is no longer as comfortable sitting in US Treasury investments. A similar thing could happen here, put your money with the government for security in our treasuries, which would give a politician another pool of money to invade. Again, not likely at this point, but certainly a possibility if history is any guide.
So, what should you do about the change?
• First, understand what category you fall under. If you need help feel free to contact us for clarification of your current situation.
• Next, discuss directly with your broker when you will be moved to lower cost investments. This rule allows brokers to do a gradual phase in of the requirements so by pushing the issue you are likely to realize the savings sooner rather than later.
• You need to ask yourself if you want to continue working with a commissioned based broker or advisor. Keep in mind that in many cases they are losing income by changing to the fee model. If they have other non-retirement accounts they manage for you and don’t change those from a product based approach it is time to move. The fiduciary rule does not cover non-retirement accounts, but these types of accounts are no less important so you should not continue being fleeced in these either. If an advisor changes one type of account and not the other then they are still more interested in their own income than in doing what is best for the client’s wealth creation.
I hope you find this information helpful as a starting point. Naturally, those against the rule stand to lose billions of dollars annually in fees. That being said every individual’s financial situation is different ranging from risk aversion levels to investment objectives. Make sure your advisor, whether you have large balances or small balances, is fee-only. That is the best manner to assure that the advisor is more concerned with your well-being than his or her income.
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