In April, the U.S. Department of Labor (DOL) made headlines with its ﬁnal rule covering
conﬂicts of interest among investment advisers. Media coverage focused on the diﬀerence between a “ﬁduciary” standard and a “suitability” standard. Financial
advisors and investment ﬁrms have been debating this issue—often heatedly—for years, and the DOL action probably will bring about changes within the industry.
The new rules also have a message for investors, especially those who rely upon an advisor. This lesson may not be astounding but it’s worth keeping in mind: You should know what investment advice is costing and whether you’re getting your money’s worth.
Deﬁning the terms
Investment advisors who are registered with the SEC are considered ﬁduciaries: They have an obligation to act in a client’s best interest. Alternatively, registered representatives associated with a securities brokerage ﬁrm are required to make investment recommendations that are suitable for a particular client, given the client’s circumstances. (Registered investment advisors are ﬁduciaries under the Investment Advisors Act of 1940 but not under ERISA, the federal law covering retirement plans; ERISA is the DOL’s responsibility, so that agency issued the rule on retirement advice.)
When issuing its ﬁnal rule in April, the DOL came down ﬁrmly in favor of the ﬁduciary standard, stating that “persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA” will be treated “as ﬁduciaries in a wider array of advice relationships.”
Investors should keep in mind that the DOL rule covers retirement advice, not all investments. Therefore, this regulation applies to advisors’ recommendations for IRAs, 401(k)s, and other retirement accounts. When Wendy Jones seeks advice on how to invest in a regular (non-retirement) account, the DOL rule won’t apply, at least not directly. Advisors who adhere to a ﬁduciary standard for retirement advice may well follow the same approach for other client funds.
Moreover, the DOL clearly associates investors’ best interests with low costs. The DOL repeatedly has mentioned “backdoor payments” and “hidden fees” as factors that harm American workers and their families. Lowering fees would boost returns, the DOL asserts.
Some observers believe that the federal support of a ﬁduciary standard will result in more advisor support of passive investment strategies and less emphasis on active management. Also, sales commissions may yield ground to fee-based advisory arrangements.
Both of those assertions may come to pass, but both trends are already well under way. Passive investing generally means holding funds that track a market index, such as the S&P 500. Such funds typically have relatively low costs, as there is no need to pay for research into security selection, and relatively low tax bills, because of infrequent trading.
Index-tracking mutual funds have been popular for some time, as ﬁnding fund managers who consistently outperform the indexes has proven to be challenging. In recent years, exchange-traded funds (ETFs) have taken market share from mutual funds; most ETFs track a speciﬁc market index. Thus, many advisors and clients have been moving towards such low-cost, tax-eﬃcient approaches.
Similarly, fee-based investment arrangements also have been on the rise. Advocates assert that paying, say, an asset management fee puts a client “on the same side of the table” as an advisor, reducing conﬂicts of interest. If a client’s investment assets grow through superior returns, so will the advisor’s management fee.
Given this background, what can you take away from the DOL’s proposal? First oﬀ, don’t focus solely on terminology. Whether you’re getting the “best” investment or a “suitable” investment for your needs, you will have to pay the advisor in some manner. Therefore, you should know how much you’re actually paying, so read all contracts, engagement letters, and other documents carefully to ﬁnd out the true cost.
Second, realize that low costs aren’t everything. Ascertain what value you’re getting for what you pay. Is your advisor providing only investment advice? If so, what results have you received? Many ﬁnancial professionals go beyond investments to insurance planning, education planning, estate planning, and other areas of wealth management. If you have such an advisor, does the total package provided to you justify the total amount of your outlays? If you are not comfortable with the answers, you may have to seek someone else to help you handle your ﬁnancial matters.