A great treat of my youth was to go out to eat in Brooklyn with my Uncle Willy. Once, showing off my sophistication, I asked the waiter what he’d recommend. I expected my uncle to applaud my urbanity, but all I got was an eye roll. “They don’t tell you what’s good. They just tell what they’re trying to move.”
Thus I was introduced to conflicts of interest (and lousy meatloaf).
It’s one thing to get bad advice from a waiter, but quite another when the advice comes from an investment advisor that you assume is working on your behalf. The cost of conflicted advice in that setting goes far beyond a bad meal. In fact, according to evidence the White House released today, under plausible assumptions regarding returns and withdrawals, conflicted advice could cost a retiree five years of her savings.
This information comes from various materials released this morning as part of an announcement by the White House regarding a long-awaited rule intended to reduce such conflicts of interest between financial advisors and folks saving for retirement. The Department of Labor has regulatory purview over this part of personal finance under the same 1974 legislation that created tax-favored Individual Retirement Accounts. Back then, however, the investment risk associated with traditional pensions was borne by the company, not the individual investor; the 401(k), where it’s up to you to manage your retirement account, didn’t yet exist.
But as the locus of investment risk shifted to individuals, the rules governing invest advice were never updated to this new environment. The result was a lot of people without a lot of investment acumen trying to wade through thickets of annuities, bonds, securities, and index funds, often guided by advisors and brokers who they assumed were wholly on their side.
Many were — but research shows that many were, and are — not always acting in their clients’ best interest, generating unnecessary fees and charges that erode retirement savings. The newly proposed rule, which does not require Congressional approval, meaning it could actually come to fruition, realigns incentives in the interest of individual investors by requiring retirement financial advisers to follow an established standard (a “fudiciary standard”) to act in their clients’ interest.
What will that mean in practice? When workers or retirees rollover their savings accounts, typically 401(k)s, into IRAs, brokers will generally not be able to recommend products that give them a kickback but diminish the clients long-term yield. The new fiduciary standard should block what honest brokers call “over-managing:” unnecessary rollovers, churning (over-active buying and selling that generates brokers’ fees at the expense of returns), and the pushing of expensive and risky products like variable annuities.
All of which turns out to be extremely costly to retirees at a time when too many older persons are financially underprepared for retirement. In what looked to me like a pretty unbiased review of the literature by White House economists, they find that conflicted advice reduces returns by about 1 percent per year, such that a poorly advised saver might end up with a 5 percent vs. a 6 percent return. They multiply that 1 percent by the $1.7 trillion of IRA assets “invested in products that generally provide payments that generate conflicts of interest” and conclude that the “the aggregate annual cost of conflicted advice is about $17 billion each year.”
As noted above, break that down to the individual level, and you’re talking about numerous years of retirement savings shifted from a retiree’s account to that of her broker.
Now, I’ve got a friend in this business who got wind of this and went ballistic. He’s an honest guy and felt impugned and I can’t say I blame him. He also claimed the $17 billion was too high. “Why?” I asked him. “What’s the right number?”
“I don’t know,” he said, “but that’s too high.”
He went on to assure me that the rule would backfire, as brokers would stop serving small savers. In fact, what looks to me like stricter fiduciary standards were introduced not too long ago in both Europe and Australia, and small savers appear to be largely unaffected.
And frankly, with true respect to my friend and everyone else in the industry who feels slighted by this rule, if it’s such a freakin’ problem to introduce measures that enforce acting in the best interests of average people saving for their retirement years, than maybe there’s a hitch in your business model.
USA Today, not exactly a revolutionary pamphlet, made this point trenchantly: “The industry opposes [the proposed rule], claiming, as they so often do in these cases, that it would limit consumer choice and increase consumer costs in a way that is particularly disadvantageous to low-income savers. It’s a disingenuous argument because there would be no impact if brokers were already acting in the clients’ best interests. What they are saying is that they are currently willing to offer their services to the low-income bracket because they will reap even higher profit from hidden costs and fees. Their opposition to the rule is virtually proof that it is necessary.”
Stay tuned, because after the internal process that today’s announcement kicks off, there’s a comment period where folks from all sides will get to weigh in. Rest assured that deep-pocketed financial sector lobbyists will flood the zone, meaning those in support of the change will need to stay vigilant.
So pay attention … and don’t order the meatloaf.