Since taking office, Securities and Exchange Commission Chairman Mary Schapiro has repeatedly stated her commitment to raising the standard of conduct that applies to brokers when they give investment advice. The goal is to ensure that the \u201cfinancial advisors\u201d employed by brokerages (including Wall Street firms such as Merrill Lynch and Morgan Stanley Smith Barney, insurers such as Allstate, and many other smaller independent firms around the country) meet the same basic fiduciary standard other investment advisors are held to when they provide advisory services. The fiduciary duty, in short, is a duty to act in the best interests of customers. Although progress has been made, this common sense proposal still faces an uphill battle thanks to opposition from a relatively small segment of the broker-dealer community and their anti-regulatory allies at the Commission and on the Hill. The question for investors is, \u201cWhy should you care?\u201d<\/p>\n
If you are like most investors, you don\u2019t know whether your financial advisor is a broker, an investment advisor, or a little bit of both. You don\u2019t know that investment advisors are supposed to act in their customers\u2019 best interests, but brokers don\u2019t have to, under their regulatory guidelines. And, trusting in your advisors\u2019 expertise and integrity, you generally do exactly what he recommends, without researching or second-guessing those recommendations. In short, you act as if your broker is required to act in your best interests even though he is not.<\/p>\n
But what\u2019s the harm? It\u2019s not as if brokers aren\u2019t regulated. And, while brokers may not have a fiduciary duty to their customers, they do have to make \u201csuitable\u201d recommendations. The point, of course, is that the difference between what\u2019s suitable and what\u2019s best for you could mean money in your pocket.<\/p>\n
Imagine, for example, that you are investing $25,000 toward your retirement savings, and your broker is trying to decide between two large cap value funds, the American Funds\u2019 American Mutual Fund (AMRMX<\/a>) or Federated\u2019s Clover Value Fund (VFCAX<\/a>). Assuming a 20-year holding period and an 8% gross return, and taking into account the two funds’ fees\/expenses and sales charges, you\u2019d have a little over $97,500 at the end of that period if your broker chose the American Funds option, compared with just over $86,500 for the higher-cost Federated option.[1]<\/a> That $11,000 difference represents money most investors can\u2019t afford to leave on the table. On an investment of $100,000, the difference between the two options rises to roughly $45,000.<\/p>\n Under the current standards, either of these funds would be considered suitable, and the broker would be free to base his choice on the one that pays him most. Under a fiduciary duty, the broker would have to recommend the fund he thinks is best for you, and if one of the funds paid him a higher commission, he\u2019d have to warn you in advance of that incentive and ignore the incentive when making his recommendation.<\/p>\n Of course, imposing a fiduciary duty doesn\u2019t guarantee that the broker will always end up making the best choice for you. The fund that looks like it would be the better option could end up hitting a run of bad luck. But it does mean the broker can\u2019t choose to ignore factors \u2013 like fund costs or long-term risk-adjusted performance record or the quality of the match between the fund\u2019s investment strategy and your investment needs \u2013 in favor of her own economic interests. Costs are a particularly important factor when making this comparison, since funds that pay the broker more are generally going to take that money out of the investor\u2019s pocket. And, as research has shown, keeping costs low is the best predictor of investor success.<\/p>\n The differences can be even more dramatic when you leave the relatively cost competitive world of mutual funds and move into variable annuities. While many personal finance writers<\/a> believe the cost of variable annuities almost always outweighs their benefits, their high commissions make them popular among a certain group of brokers who market their services to middle class and rural investors. One analyst estimates<\/a> that variable annuities transfer approximately $25.6 billion a year \u201cof spendable investment returns\u201d from vulnerable investors to these salesmen.<\/p>\n With that much money on the table, it should come as no surprise that these same variable-annuity-selling broker-dealers are among the most passionate opponents of the fiduciary standard. After all, under a fiduciary duty they\u2019d have to forego the high payouts from sales of variable annuities if the investor would be better off in a different investment product or using a different investment strategy. At the very least, they couldn\u2019t load up the annuities they sell with a lot of features that increase their own payday without offering fair returns for the investor. Ultimately, if product sponsors had to compete by offering features that benefit the customer, instead of competing by offering more generous compensation to brokers, the benefits of a fiduciary duty could really add up.<\/p>\n My point is not that the broker-dealer business model has no redeeming features. Many investors prefer to pay for investment recommendations through commissions on a transaction-by-transaction basis. Others simply can\u2019t afford or don\u2019t have sufficient assets to justify the higher and\/or ongoing fees that often accompany comprehensive financial planning or on-going portfolio management. For these investors, the SEC proposal offers the best of both worlds. It preserves the ability of brokers to charge commissions and offer transaction-based recommendations, but it requires them to disclose and \u2013 even more important \u2013 appropriately manage those conflicts of interest. And it requires them to make recommendations that put the customer\u2019s interests first. It is a proposal that deserves investors\u2019 enthusiastic support.<\/p>\n If you believe brokers should have to act in their customers\u2019 best interests, let the SEC know. You can send them an email to rule-comments@sec.gov<\/a> (include File Number 4-606 in the subject line). And, while you\u2019re at it, send a copy to your member of Congress<\/a>.<\/p>\n * * *<\/strong><\/p>\n [1]<\/a> The comparison was made using the FINRA Fund Analyzer available at http:\/\/apps.finra.org\/fundanalyzer\/1\/fa.aspx<\/a>. The Federated fund chosen for the comparison is not a particularly high-cost fund. On the contrary, its 1.2 percent expense ratio is just about average for this fund category.<\/p>\n","protected":false},"excerpt":{"rendered":" Since taking office, Securities and Exchange Commission Chairman Mary Schapiro has repeatedly stated her commitment to raising the standard of conduct that applies to brokers when they give investment advice. The goal is to ensure that the \u201cfinancial advisors\u201d employed by brokerages (including Wall Street firms such as Merrill Lynch and Morgan Stanley Smith Barney, […]<\/p>\n","protected":false},"author":129,"featured_media":7220,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[1282],"tags":[1300,1287,1301,1292,1580],"coauthors":[82],"class_list":["post-1433","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing","tag-fiduciary-standard","tag-financial-advisors","tag-investing-mistakes","tag-mutual-funds","tag-variable-annuities"],"acf":[],"yoast_head":"\nMassive transfer of money<\/h2>\n
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