The Department of Labor recently abandoned its fiduciary duty rule for retirement advisers. The Department was responding to a recent Court of Appeals decision overturning the rule completely.
So what does this mean for you and your investments if you are working with (or plan to work with) an advisor?
Make sure you know the following three things to protect yourself and to maximize your investment performance.
- Know the duty your advisor owes you and scope of that duty.
- Understand your advisor’s compensation model.
- Ask how the performance of a portfolio of low-cost index funds compares to the performance of the investments recommended by your advisor.
I wrote favorably about a fiduciary standard because it puts your interests first and not the profit interest of the advisor. A financial advisor without a conflict of interest seemed right to me because people are on their own to secure their retirement. And many folks, if not most, don’t have the time or skill set to do so appropriately.
Many brokerage firms and advisors, nonetheless, had begun to comply with the rule and had banned products with commissions for retirement accounts and transitioned accounts to fee ones. These activities are now in flux with the shifting regulatory groundwork.
Nonetheless, you can still protect yourself if you follow these three considerations.
What is the Scope of the Advisor’s Fiduciary Duty?
Financial advisors, such as stock brokers and annuity sales persons, offer advice about and sell financial products that may only be “suitable” for consumers. As a result, advisors can recommend products that pay them more but are more expensive and give lower earnings to investors.
The recently suspended rule sought to change this regulatory scheme for retirement investors.
A fiduciary duty requires that the advisor put the client’s interest before their own profit interest. A fiduciary is the “purchaser’s representative.” The duty requires the person to have loyalty to the client. The advisor does not represent the financial product provider.
Investment advisors that are Certified Financial Planner™ professionals have a fiduciary duty to their clients. Their duty runs to all aspects of financial planning – not just to their investment advice. You can verify a CFP®’s credentials here.
Registered investment advisors (“RIAs”) regulated by the Securities and Exchange Commission (SEC) also have a fiduciary duty. But their fiduciary duty applies to investment management only and not to broader financial planning, which considers a client’s entire perspective. You can check their credentials here.
Securities brokers, sellers of annuity products, and insurance agents do not have this duty if they aren’t CFPs® or RIAs. Although the SEC is working on its own version of a fiduciary rule that would apply to all brokers and accounts – not just retirement ones – it is still in the rulemaking process.
How to Check Your Advisor’s Duty and Compensation Practices
So if you are working with an advisor or plan to work with one, make sure to understand whether they have a fiduciary duty to you and the scope of that duty.
A good place to start is with the advisor’s Investment Brochure. The SEC requires every advisor to have an Investment Brochure. It describes in “plain-language” their background, compensation, and investment approach.
Although the SEC requires your advisor to give their brochure each year, you also can access them online here. The Investment Brochure also explains the advisor’s compensation model. Is it hourly fees, commissions, a percentage of the assets they manage, “revenue sharing fees” for recommending certain mutual funds, or a flat fee? The Investment Brochure will list these sources and their relative proportions for the advisor.
Review Investment Performance
Even if the advisor is a fiduciary it doesn’t say anything about the portfolio’s performance. I believe a portfolio’s performance matters most to investors.
Most investors don’t care if the advisor is getting paid to recommend superior products. But they bristle when their advisor is pushing sub-par products or ones with high fees just because they enrich the advisor.
Ask your investment advisor for a comparison of the actual performance of the recommended mutual funds or Exchange Traded Funds (ETFs) to a hypothetical portfolio of low-cost Vanguard index funds. Index funds just track overall market performance. The comparison should cover at least five to seven years of actual performance.
The benefit of this approach is that it looks at real data from real funds.
Although past results are not guarantees of future results, they are useful for comparison purposes. This approach also guards against buying new “backtested” products that don’t have any real market experience.
I wrote before about the specific parameters you should seek in asking for a hypothetical portfolio.
In sum, seek an advisor who is a fiduciary. You should understand how they are compensated. Also ask for an analysis of whether their recommended investments outperform a similar portfolio of low-cost index funds.