It’s hard to argue with the intent of the Labor Department’s proposal, announced on Halloween, to increase the number of financial professionals subject to a fiduciary standard.
That standard, in essence, requires financial professionals to give priority to clients’ best interests over their own. But even if the DOL’s proposal is eventually adopted after public hearings and a lengthy comment period, it will remain the case that you are your best defense against unscrupulous advisers.
That’s because violations of the fiduciary standard often boil down to intent: Does the financial professional sincerely believe he is acting in your best interest? Does he genuinely believe that what he’s recommending to you is prudent? That’s notoriously hard to determine, let alone enforce. Sometimes the professional will himself be unaware of his unconscious bias and conflict of interest.
Read: You can save up to $23,000 in your 401(k) next year, IRS says
To illustrate how difficult it can be to separate advice that is appropriate from that which is inappropriate, consider the following two possibilities for what you can do with your 401(k) when you retire:
- Invest it in a fixed index annuity (FIA) that carries a 6% commission
- Roll it over into an IRA managed by an adviser who charges a 1% fee per year
Almost everyone to whom I present these two options insists that the former is outrageous; it’s a paradigmatic case of an insurance agent gouging a new retiree. And there is no shortage of examples of this unscrupulous behavior.
Nevertheless, there are some who sincerely believe the FIA can be preferable. A FIA pays out a share of the gains produced by an index such as the S&P 500, while simultaneously protecting against any losses. For those who are particularly risk averse, FIA may be worth the price. And, in any case, a 1% annual management fee over many years can add up to a larger sum than the FIA’s commission.
This admittedly is an extreme example. And by no means is it my intent to defend those insurance agents who shamelessly prey on naïve clients, which happens often enough to give the insurance industry a terrible reputation. That bad reputation was in full display when I interviewed several industry professionals about the DOL’s proposed retirement security rule. One said in an email that “the insurance industry may be the country’s largest repository of criminal activity.” Another agreed, adding that “insurance was a wonderful invention until it fell into the hands of the insurance industry.”
That said, my 40+ years of auditing investment advisers’ returns has taught me that there are many different roads to riches, some conventional and some unconventional. The threat of legal action can lead advisers to recommend what’s considered conventional wisdom rather than what they think may actually be the better course of action.
Consider the “prudent man rule,” which is at the heart of what it is to be a fiduciary. This rule traces to a famous 1830 court case involving Harvard in which the court said that a trustee [someone with a fiduciary obligation] “shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs.”
Yet the history of the financial markets is full of examples of “men of prudence, discretion, and intelligence” doing stupid things. Though it may provide you with legal cover to do so, does that mean you should follow them over a cliff?
I’m reminded of John Maynard Keynes famous line that “it is better for reputation to fail conventionally than to succeed unconventionally.”
The bottom line, according to David Blanchett, head of retirement research at PGIM? It’s a good thing to demand that financial professionals bear more responsibility than some of them have today, and though the final wording of the DOL rule is still to be determined, it most likely will do that.
Still, even when your adviser is operating under the umbrella of a fiduciary standard, it will be important for you to ask hard questions of your adviser and judge for yourself the quality, honesty and sincerity of his answers. I say that not because I don’t want to hold up advisers to the highest possible standard, but because laws and regulations are unable to completely protect you against bad advice.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].
Read the full article here