When you go to your doctor, he or she has an official duty to offer you the best possible care—that’s what the Hippocratic Oath is all about. But until now, when you’ve gone to see an investment broker or retirement planner, the same hasn’t necessarily been true. Financial advisors, brokers and other such professionals have been able to offer all sorts of products that aren’t necessarily in their clients’ best interest, as long as they qualified as “suitable,” a very low bar to pass.
That’s all about to change. After years of wrangling with lobbyists from the financial industry, the Department of Labor has finally managed to pass a new fiduciary requirement, set to take effect next year, that would require brokers and many sorts of financial advisors and planners to offer investment advice that is in their clients’ “best interest.” That means that they have to put clients’ needs above their own financial benefit, even if they lose money in the process. (Most likely from fees associated with selling certain types of investments.) That means you are going to see a raft of money flowing out of higher fee mutual funds in the next few years, and into low- or no-fee indexed products.
That’s going to save all of us a heck of a lot of money. “Defined contribution” retirement plans, like IRAs and corporate-run 401(k)s, represent $12.4 trillion in wealth. Yet the system is opaque, expensive, and serves mostly the upper 40% of our society, people who work in the kind of jobs where they can benefit from corporate programs that match their savings. But even many of those people are being fleeced by financial advisors. They have long tried to push investors out of index funds and into mutual funds that systemically under-perform the market as a whole, often because of manic trading that rarely produces gains over the long haul. (Though they might show higher returns in the short term.)
For this, brokers may collect fees from various funds they are representing – but we all end up paying more for less. A particularly telling 2014 piece of research done by Yale academics found that index funds always outperform actively managed portfolios by a significant amount ‚ and that 16% of the time, the impact of high fees actually offset the entire tax benefit of investing in a 401(k) plan. In another study on the topic, Stanford professor and Nobel laureate William Sharpe calculated that investing in low- or no-cost funds rather than actively managed funds would save people so much money that it would result in a 20% higher standard of living in retirement.
Jack Bogle, the founder of Vanguard Funds and longtime index investing advocate, has run his own numbers, including not only the lower returns for active funds but additional hidden fees from portfolio turnover costs, charges for investment advice and other such expenses. As he put it in testimony before the Senate Finance Committee, “The high cost of ownership of mutual fund shares, over the long term, are likely to confiscate as much as 65% or more of the wealth that retirement plan investors could otherwise easily earn, simply by diverting market returns from fund investors to fund managers.” He adds, “Many of the infirmities of our retirement system are the result of the heavy costs incurred by investors because of our bloated financial system.”
Amen. While investors will still have to read the fine print when they sign up for investment advice (not all advisors will be included in the new rules all of the time), most of us will, by next year, be able to rest assured that we are getting the financial advice we really deserve. That’s particularly good news as the market moves into what may be years of higher than normal volatility.