Last week, there was a major development regarding financial
advice in this country. At its core, the concept is a good one – advisers have
to put their client’s interest first. For many people, this represents a
surprise because after all, one would assume this has always been the case.
The rules govern retirement accounts such as 401k and IRAs,
but do not consider other types of accounts like 529 plans. That means when you
get financial advice for retirement accounts, providers have to act in your best
interest, but when dealing with non-retirement money, advisers just have to
provide “suitable” advice.
It’s a very fine line.
The underlying reason for the rule is flawed – it basically
assumes that financial advice givers are shady thieves. I personally take offense to this.
The rules also favor certain products and providers over
others. Index funds, with their low cost, are favored but that doesn’t mean
index funds are right for everyone. And robo-advisers, investment services
driven by computer programs, are also favored but certainly do not provide any
guarantee against loss despite their low cost structure.
Compensation rules also change. Fee based compensation is
the preferred method over commissions, but the fear is that smaller investors
will lose access to professional advice, which I predict.
Why?
Commissions are neither good nor bad. After all, real estate
agents and many other professions are paid this way. Fees are designed with
fewer potential conflicts of interest, in theory. You could pay a flat fee for
advice – a set amount, or set amount per hour like an attorney. Or you can pay
a fee that is more typical, which is a percentage of amounts invested, known in
the industry as an AUM (assets under management) fee.
The idea behind an AUM fee is that your interest is aligned
with the adviser. The more your account goes up, the more they make. But even
that has an inherent conflict. What if you need to take money out to pay cash
for a house? Your adviser’s AUM would go down and so would the fee, so would
your adviser give you that advice?
The real key difference for smaller clients is this: the
process to invest $1 million is the same as to invest $100,000, but the pay is
a lot less for the smaller account. But the potential for legal liability is the
same!
The alternative is to pay a flat fee or hourly charge. I've personally seen anywhere between a few hundred dollars to $10,000 for a financial plan, or up to hundreds of dollars per hour! It's like paying an attorney to handle a big legal case. At least in that instance, you know legal cases come to an end eventually. Your finances don't "end".
The bottom line is this - if you find an adviser you trust, then these rules really don't matter. But be educated and engaged with your adviser.
I personally always try to do the best for my clients and their needs, because reputation is more important than money. Plus, going to jail or getting fined are really big detours in business and life!
The important aspect these rules miss is that a person's entire financial life works together - retirement, debt, taxes, etc. These rules only address one aspect of a person's finances. To me, that just doesn't make sense.
There will be more details to come on these rules, and I'm sure there will be changes.
