Yesterday, the headlines were full of the news that Texas federal trial Judge Barbara M.G. Lynn had ruled in favor of the Labor Department, and against financial industry challengers as well as the Trump administration, on the DoL’s proposed “fiduciary rule.” Her decision marks the third time challenges to the rule have been shot down in the courts. Wondering what all the fuss is about?
Many people don’t realize that some advisors and brokers can offer investment advice that isn’t in their best interest. In other words, some kinds of advisors and brokers can recommend an investment that pays them (the advisor) a high commission or a high fee, even if there is a comparable investment option that would cost the client less.
The Obama Administration’s Council of Economic Advisers estimated that investors (you and I) are spending $17 billion a year on these kinds of fees and commissions. A rule proposed by the Department of Labor (DoL) in 2010, known as the “fiduciary rule,” would require money managers and advisors who sell financial products to investors for their retirement accounts to act as “fiduciaries.” This means that financial advisors and brokers would have to put their clients’ interests first when providing investment recommendations for their tax-advantaged retirement accounts.
The idea is that the fiduciary rule will stop advisors from putting their own interests first, and clients will benefit because they will be paying lower fees.
Here’s how this works: Say, for instance, your investment advisor or broker recommends an investment fund to you, Fund A, which is a U.S. stock fund. The annual fee you pay to invest in the fund (to the fund management company, not your advisor or broker) is 0.95 percent per year (on the amount you invested) and your advisor or broker receives a 5 percent commission on the amount you invested.
Now say there is another investment fund that also invests in U.S. stocks, Fund B. It only charges you an annual fee of 0.15 percent (as opposed to 0.95 percent) and there is no commission tied to this fund. Some advisors and brokers might recommend Fund A because they receive a commission on that fund, even though it wouldn’t be the best choice for you. This happens often and it’s completely legal.
It’s a lot like when a realtor only shows you apartments she makes a commission on, and doesn’t show you no-fee apartments that would suit you just as well.
The fiduciary rule is intended to address these conflicts of interest. Advisors and brokers would no longer be able to put their own interests before yours when giving you investment advice for your tax-advantaged retirement accounts. It’s important to note that the rule would not apply to any after-tax investments you may make, even if that money is earmarked for retirement. In a regular brokerage account a broker or advisor would still legally be allowed to recommend investment products that may charge higher fees to you, but provide them a commission, rather than a similar product that had lower fees for you and no commission for them.