The DOL Fiduciary Rule – The Evolving Landscape of Advice

Personal Finance

You’re a young professional looking for financial guidance and already intimidated by the prospect of finding someone you can trust, let alone someone knowledgeable and willing to work with you given that you don’t yet have a portfolio with six zeros next to it, and then April 6th happens.

Headlines like the following start popping up on every cable and network news channel: “Obama: Financial advisors must act in clients’ best interest” or “White House says investment advisors must act in clients’ best interest.”

And you start to wonder, wait, you mean advisors don’t have to act in the best interest of their clients?

Unfortunately the answer is not a resounding “yes they do,” but rather a “well some do and some don’t.” Fortunately for young professionals and consumers as a whole, recent legislative changes from the Department of Labor (DOL) will provide investors with more protection.

The Evolution of the Investment Industry (and How That Has Created Issues Today)

To get a better understanding of the recent changes, it helps to take a step back to examine the evolution of the investment industry. Over a half century ago, the industry began to evolve into two primary channels: the Broker Dealer channel and the Registered Investment Advisor channel.

Broker dealers historically—as the name implies—brokered the sale of stocks and bonds on behalf of companies to the public. If a company like General Electric (GE) wanted to raise money, it would sell its stock to a broker dealer in exchange for cash. In turn, the broker dealer would sell the stock to public investors and charge a small markup on the sale as a means of earning a profit (i.e., a commission).

In short, broker dealers were simply intermediaries for the sale of stock—think no different than your local car dealership is an intermediary for selling cars—and the agents who facilitated the sales between willing buyers were known infamously as stockbrokers.

Now contrast the broker dealer channel with that of Registered Investment Advisors (RIA) or more commonly referred to as advisors who historically did not sell product, but rather provided ongoing investment guidance for a fee (which historically has been a flat percentage of the money managed).

Everything seems pretty straightforward, right? That is until technology enters the picture.

Like many industries, the investment world has not been able to avoid the disruption that comes with technology. As online discount brokerages—think of those talking baby eTrade commercials—have evolved, it has put massive pressure on traditional broker’s margins. Consumers no longer needed to call their “broker” to buy stock of Ford or GE, they could simply purchase shares of the stock online.

This trend—which closely resembles that of Amazon causing disruption in the book marketplace—has caused brokers to reinvent themselves and begin to shift more towards an advice model and that’s where confusion begins.

Your Best Interests Versus It Probably Won’t Harm You

Historically, brokers have had to operate under the standard of “suitability,” which essentially means they can sell you something as long as it is suitable. Think of it like this, you go to the butcher and tell the butcher, Big Jim, you’re having a barbeque over the weekend. He suggests the tasty lobster just in from the East coast and as long as he knows you aren’t allergic to the lobster, that it won’t make you sick and that you can afford it he can sell it to you—it’ suitable.

Never mind the fact that “just in” actually means the lobster is a week old or that Big Jim receives a bigger commission for selling you the lobster than he would on the steak. Again, suitability simply means it probably won’t harm you, but it might not be the best option for you.

Contrast the suitability standard with that of the fiduciary standard where an advisor is required to act in the client’s best interest. Using a similar analogy, an advisor would have to operate more like a dietician. He or she would likely take body measurements, ask you some questions about what you like and don’t like, any food allergies you might have, any concerns you might have about your diet, what your goals are when it comes to eating healthier, etc.

The dietician—much like an advisor—gets to know you, your family, and your situation so that the advice provided is ultimately in your best interest, not merely up to a level where it probably won’t hurt you.

To be clear, it’s important to note that brokers (and butchers) are not inherently bad. Sometimes you just want to purchase lobster or GM stock and don’t want to go through the whole process of getting your BMI tested just to do so. However, the issue arises when consumers cannot determine if an advisor is operating like the butcher or the dietician.

The Changes and What it Means for Young Professionals

The recent DOL changes are a big step in the right direction in helping to ensure that consumers receive fiduciary advice—that is in their best interest. The following are four critical takeaways for consumers given the recent legislative changes:

  1. The recent legislative changes don’t go into effect until January 1, 2018.
  2. Any form of advice provided to individuals—whether from an advisor already held to a fiduciary standard or a broker held to the suitability standard—on their retirement accounts (i.e. IRA, 401k) must be given in the individual’s best interest.
  3. Unfortunately the above standard does not apply to brokerage or taxable investment accounts, so the DOL has inadvertently created a double standard depending on what type of account money is held in. Expect this to be fixed at some point in the future.
  4. In order to provide advice around what to do with an old 401(k), extra steps must be taken by an advisor or broker to ensure that the advice is in the best interest of a client.
  5. If an advisor/broker will be compensated in a manner that the DOL deems as conflicted, the client and advisor/broker must sign an additional agreement recognizing that the advisor is doing so in the best interest of the client.

How to Find Someone Who Will Do What is Best for You

One of the primary goals of the recent legislative changes is to raise the minimum standard of advice to the fiduciary level for all retirement focused accounts—unfortunately the law does not extend to non-retirement accounts, which is a distinction worth noting again.

So in a world where virtually anyone can hold themselves out as an advisor what steps can young professionals take to ensure that the individual working for them is actually acting in their best interest (and is qualified to do so)?

  1. Registered Investment Advisor (RIA): RIAs are legally required to act in the client’s best interest. To determine if an advisor or an advisor’s firm is registered as an RIA with the Securities and Exchange Commission (SEC) click here. If they are not, don’t panic. Many advisors, particularly those at smaller shops, are actually required to register with the state and not the SEC.
  2. Certified Financial Planner: The CFP® designation is considered to be the premier designation in the financial planning space, and helps to ensure that an advisor has a minimum level of experience, has been through a rigorous education process and has passed extensive examinations testing their knowledge. Check to see if your advisor is a CFP® here.
  3. BrokerCheck/Investment Advisor Disclosure: Do your homework! You can look up your broker here on BrokerCheck to see if they have had any disciplinary actions on their record. For advisors registered with the SEC or as an RIA with the state, check here.
  4. Don’t be afraid to ask tough questions: Ultimately the responsibility for finding someone you trust falls on your shoulders—no different ultimately than any other transaction—so it is critical to not be afraid to ask the difficult questions. Some examples might include: do you operate as fiduciary and will you put that in writing? Are you paid by anyone other than me? How are you paid?

Lastly, it’s important to note that in any business, it is virtually impossible to eliminate all conflicts of interest. And most rational people don’t expect conflicts to be completely eliminated, but rather that they be fully disclosed. Any time you’re working with an advisor or broker be sure to ask about conflicts of interest and what processes are in place to help mitigate those conflicts.

Ultimately being a well-informed consumer amidst a clouded landscape of evolving regulations governing financial advice is critical to ensure your own financial well-being. The good news is that the industry is changing—albeit not fast enough—towards one uniform standard of keeping clients interest first, always. Until then, always do your homework.

 

 

About Matt Cosgriff, CFP(®)

Minneapolis Financial Planner | Intrapreneur | Young Professional | Millennial Guru | Tech Aficionado | Traveler | Food Lover | Minnesota Wild Fan | Movie Quoter | Follow on Twitter| LinkedIn

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