You know setting aside money for retirement is smart, but you don’t know anything about how it works. You need advice. Where do you turn?
Maybe you have a financially savvy friend or family member. But a lot of people turn to professional advisers.
Until now there have been two different kinds of investment advisers: those who are required to work in your best interests, and those who — amazingly — are not.
But a new rule from the Department of Labor, which becomes final today, aims to change that. Under the new rule, savers will gain the right to sue or initiate arbitration against advisers who don’t meet high ethical standards or who fail to disclose conflicts.
The effect, say both experts and many industry advocates, will be to drive many advisers to change their business models, while pushing others entirely out of the business.
And that’s probably a good thing.
The new rule will require retirement advisers to act in their clients’ interests
The Department of Labor developed the new standards over the past few years, as part of a larger regulatory effort to reduce risk for middle-class savers after the 2008 financial crisis.
The two kinds of retirement savings pros are called "registered investment advisers" and "broker-dealers." Registered advisers — who often work with wealthier, more sophisticated clients — are required to uphold fiduciary standards, a special legal arrangement most often associated with lawyers and doctors. They are required to work in the best interests of their clients and can be punished for doing otherwise. Registered advisers are paid directly by their clients, and generally charge based on the size of the fund they manage.
"Broker-dealers," on the other hand, are often more like salespeople (a dealer is a broker who works independently). They’re often paid commissions, increasing their incentive to suggest products with higher fees. Many also receive "revenue-sharing" payments from the banks and mutual funds that generate the investments the brokers sell, again potentially influencing them to steer savers toward products that charge more.
The suggestions broker-dealers make to clients are held to a "suitability standard." That is, brokers are required to only propose products that are appropriate for the saver given his or her age, retirement goals, etc.
What brokers dole out is "advice" in the conventional sense, but the current rules don’t require it to be particularly good, or even fully well-meaning.
"A sales pitch where they're going to get a huge commission isn't ‘advice,’" says Betsey Stevenson, a professor of economics and public policy at the University of Michigan and a former member of the White House Council of Economic Advisers (CEA) who co-authored its report on the rule.
"Car salesmen get commissions, and everyone’s fine with that," she adds. "But I've never met anyone who's going to go to a dealership to ask advice about whether to buy a new car or take the bus."
Savers lose a lot of money because of conflicted advice
A decades-long shift from traditional pensions to 401(k) savings plans means more people than ever are responsible for deciding where to invest their own retirement savings.
The CEA’s report, published in February 2015, found that bad advice from conflicted broker-dealers reduced savers’ returns by about 1 percent a year — as much as $17 billion a year nationwide.
The greatest losses occur when workers roll their 401(k) balance into a higher-fee individual retirement account when leaving a job, rather than keeping it with their former employers.
"A typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17 percent from her account by age 65," the CEA’s report said. The report adds that if there is $100,000 in that account, it could grow to $216,000 in 20 years without the bad advice, as opposed to $179,000 with the conflict of interest.
Opponents say conflicts of interest aren't a problem
Opponents of the new rules argue that most brokers already act the way regulators want them to.
"If you don’t help someone, they’re not going to continue with you as a client," said Lisa Bleier, managing director at the Securities Industry and Financial Markets Association, an industry group, in a December interview.
Bleier said the Labor Department’s proposed rules were haphazard, applying only to retirement advisers and not to investment advisers generally. They’d require savers to sign extra contracts, including one the moment they walk in the door, she said, and would expose brokers to frivolous lawsuits.
I pressed Bleier on the ethical issues involved in advisers receiving commissions or revenue-sharing arrangements. "I don’t see those compensation structures as a problem, no," Bleier responded. "The SEC has approved them."
The new rule will probably drive a lot of advisers out of the business
Both Stevenson, the professor and former Obama administration economist, and Bleier agree on one likely effect of the rules: A lot of brokers will stop serving middle-class clients.
Broker-dealers will have three options:
- They can operate as they do now, but adhere to the new standards. Because it’ll be harder to steer clients toward high-fee products, they’ll make lower commissions — while still risking lawsuits from disgruntled clients.
- They could move away from commissions, charging the client a fixed fee the way registered advisers do.
- They could give up advising entirely.
In late 2012, the UK passed a set of regulations that were similar to the Obama proposal — but stronger. The regulations not only imposed a fiduciary standard on retirement brokers, but also banned nearly all commissions, while also strengthening disclosure and professional training requirements.
The result: The number of advisers in the UK fell from about 27,080 in 2009 to 23,640 in 2014, a reduction of about 13 percent, according to the Association of Professional Financial Advisers.
The revenue generated by advisers was impacted as well. Advisers’ total income never fell, but it stopped growing for three years, from 2011 to 2013. But growth resumed in 2014 with a surge of fee-based income replacing a very large drop in commissions. (Outside factors like the eurozone debt crisis likely influenced advisers’ revenue, as well.)
In the years since the new rules went into effect, both government and industry have expressed concern about a growing "advice gap" for middle- and lower-income retirement savers. While regulators have said it's difficult to measure the gap — measuring something customers aren’t doing — a research firm called Fundscape found, based on survey data, that many advisers were turning away investors who had less than about $148,000 in total assets. The average British investor has a portfolio of about $30,000.
Bleier and Stevenson both believe something similar will happen here in the United States — less wealthy clients simply can’t afford the upfront fees charged by non-conflicted investment advisers. But while Bleier sees that as a big problem, Stevenson disagrees.
Stevenson argues that most savers would be fine with so-called robo advice from online services that use data and algorithms to offer advice based on savers' specifications. Another option: They can read the Vox guide to retirement savings.
"It’s not about good guys and bad guys," said Stevenson. "These guys are just trying to feed their families. And if they can offer a product where they get a $500 commission versus one where they get an $800 commission — they don’t want to give bad advice, but what if it’s hard to tell?"
With the fiduciary rule, the government aims to resolve that tension and legally obligate advisers to put aside their self-interest. The result for savers, though, won’t necessarily be better advice. It could be less advice, at least of the kind you get from human beings.
But that’s okay. Most people don’t need much advice, because the principles of saving for retirement aren’t complicated: Save 20 percent of your income, invest in low-cost index funds, and don’t touch the money until you reach your retirement age.