Incentives are a key part of understanding any financial transaction. What are the incentives of the person sitting on the other side of the table? Does the financial advisor recommending an investment that he/she earns a large commission on really care about the long-term performance of that investment? Students may be interested to learn that advisors today do not have a responsibility to their clients first. But that may be changing…
The NewsHour (5 minute video) reports on the fight over new regulations to ensure that financial advisors put the interests of their customers first (are you surprised that this is not a requirement already?):
The root of this dispute is that the Department of Labor wants to change the rules governing retirement advisers. And these are people you go to if you need help with your 401(k) or rolling over your IRA, things like that. And the Department of Labor wants to change it so that all these advisers have to have what is called the best interests of their client at heart.
Now, many of us might think, well, doesn’t my adviser already have my best interest at heart? And most of them do, but not all of them, and not all of them are legally required to do so. So, that can sometimes mean that you might get sold a plan that has a lot of higher fees that is maybe not the best plan for your retirement future. And so the Department of Labor wants to say, OK, put your clients’ interests ahead of you, ahead of your own across the board.
What is the cost of this conflicted advice?
The White House estimates that $17 billion is lost every single year by advisers who are getting what they call this conflicted advice, where you’re sold something where the fees are higher than they should be or that is just not the optimal plan for you.
And the complicated issue here is that there is a dizzying array of retirement options out there. And it’s very difficult for people to know where to turn, so naturally they seek advice.
Here was a good analogy they used comparing financial advisors to car mechanics:
One of the advocates that I spoke with likened this to when you’re driving down the road in your car, and, all of a sudden, you hear a big bang coming out of your engine. You take it to one mechanic and he says, that’s $1,500 because you have got to replace your transmission.
Take it to another mechanic, he says, oh, it’s $1.99 for a spark plug. Unless you’re an auto mechanic, you just don’t know, well, who’s right and who’s wrong. And some of the advocates argue that financial advice is the same way.
What advice would I give my students about financial advisors? Ask your advisor one question: How are you being compensated? If you are not comfortable with the answer and don’t feel your interests are aligned, walk away.
I am reminded of this Upton Sinclair quote when people ask why a financial advisor would recommend a high fee mutual fund that likely would underperform a similar low fee index fund:
It is difficult to get a man to understand something when his salary depends on his not understanding it.