06.17 Are Salespeople Investment Advisors?
One of the big issues in the investment world is a change proposed by The Department of Labor (DOL) in the definition of fiduciary under the Employment Retirement Income Security Act (ERISA) that would broadly expand the scope of those who become fiduciaries. ERISA governs employer-based retirement plans such as 401(k)s and retirement vehicles like IRAs, and this type of change is being considered due to studies like this report released by the Council of Economic Advisers.
Why should an investor care about this somewhat wonky issue? According to the CEA, more than 75 million American families have savings of more than $7 trillion in IRAs and rollovers to IRAs exceeded $300 billion in 2012 and have surely increased since. IRAs can contain a wide variety of investments and the DOL is concerned that the way these investment products are being sold generates significant conflicts of interest that result in diminished returns to investors. The provider of investment advice may be incented “to steer savers into products or investment strategies that provide larger payments to the advisor but may not be the best choice for the investor.”
The CEA estimates that conflicted advice tends to lower returns to investors by about 1% per year, and that an estimated $1.7 trillion of IRA assets are invested in products that generate conflicts of interest, so the annual cost of conflicted advice is about $17 billion annually. Put another way, the average IRA rollover for individuals over 55 in 2012 was more than $100,000, and according to the CEA, the average retiree could lose 12% of the value of his savings over 30 years due to conflicted advice—as if $12,000 was lost in the transfer.
How does an investor protect his retirement savings from conflicted advice? First, here is a brief explanation of the difference between an investment advisor acting as a fiduciary and an “investment advisor” who is really a broker, i.e. a salesman.
An investment advisor acting as your fiduciary requires the advisor to act with prudence, loyalty and care. The advisor should put the client’s interest ahead of his own – all fees and any conflicts should be disclosed in a written contract prior to any investments being made on behalf of the client. The fiduciary advisor will charge you a contractually agreed upon fee to provide financial advice and receive no other compensation from the providers of the financial products he chooses. Therefore, he is incented to choose the best performing, lowest fee products that he can find. The advisor is sitting on the same side of the table as the client. What is best for the client is also best for the advisor.
A broker is someone who sells financial products. They adhere to the suitability standard. They are required to offer suitable investments to their clients. That may not mean the lowest fee or best investment choices. A no-load index fund may perform as well as a mutual fund with a high up front load, but the broker has little reason to sell the index fund if both products are suitable for the investor. The fees for many products are hidden and can be quite high. For the venerable mutual fund sold in the traditional manner, a front-end “load” or commission of 5% isn’t uncommon. And add to that 12b-1 fees, marketing fees, and account maintenance fees that could average about ½ of 1% annually. That is a big hit to investment performance before the horse leaves the gate.
Ask your financial professional if he or she is acting as your fiduciary. Some brokers call themselves financial advisors but are, in fact, salesmen of financial products. There is nothing wrong with selling financial products and brokers can provide great services to those that don’t need or want a personal investment advisor.
If your financial professional is not acting as your fiduciary, ask him what the fees are associated with the investment products he is selling you and why he is recommending a particular product. Once you know in what capacity your financial professional is acting (fiduciary or salesman), you can ask the right questions to protect your money and give you the opportunity to achieve the best investment results.
James Mathis, Managing Partner, Echelon Investment Management