Column: Why you should make sure your financial adviser abides by the fiduciary standard

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Young businessman talking with couple. Male financial planner explaining investment plans to clients. They are in office.

President Trump may reverse an Obama era executive order that would make financial advisers operate under the fiduciary rule. Don’t let that stop you from insuring your financial adviser operates in your best interest, writes Harold Pollack, author of “The Index Card: Why Personal Finance Doesn’t Have to Be Complicated.” Photo by Portra via Getty Images

Depending on your political views, you’re either energized or angered by what President Trump’s election might mean for immigration, health care and other national concerns. Wherever you stand on these issues, Nov. 8 brought another policy change you may have overlooked, but will likely affect you personally if you are seeking retirement investment advice.

President Obama’s Labor Department developed an executive order creating new consumer protections to people making retirement investments. Set to take effect in April, this “fiduciary rule” would require investment professionals to provide retirement advice and sales pitches that advance their customers’ financial interests, rather than advice that benefits their own sales commissions or other compensation.

Financial firms generally hate and oppose the fiduciary rule for basically the same reason consumer advocates love it: It would lower Wall Street’s profits and fees.

Financial firms generally hate and oppose the fiduciary rule for basically the same reason consumer advocates love it: It would lower Wall Street’s profits and fees. Congressional Republicans have joined the financial industry’s efforts to oppose the rule, and President Trump has moved to delay and roll back the new rule. Former Goldman Sachs executive Gary Cohn, who now heads President Trump’s National Economic Council, recently told the Wall Street Journal, “It is a bad rule for consumers.” No one precisely knows what will happen to the fiduciary rule under President Trump, though most observers believe it will be repealed or substantially weakened.

Observing this controversy, you might assume that such a rule is merely a bureaucratic nicety, since financial professionals are already required to provide unbiased advice.

But actually, they are not. Instead, they are generally held to a “suitability” standard, under which they are required to offer you investment products that are “suitable” to your needs, which is a very different thing.

How different? Suppose that you’re 40 years old and that you’ve been lucky enough to build up $100,000 in an IRA. You’ve just changed employers, and you’re sitting in the storefront office of a prominent financial firm, which we will give the fake name “Grow-well.” You and a Grow-well representative are discussing the options for rolling that IRA over into some other investment. A cheap index fund is available that charges 0.1 percent annually. Another, basically identical product is also available. That one charges 0.4 percent annually, but provides an additional commission to Grow-well for each new customer.

Under a fiduciary standard, your Grow-well representative is obligated to offer the cheaper fund. Under a suitability standard, she can recommend the more costly fund and not to tell you that the cheaper alternative is available. After all, both funds are suitable to your needs, even though one will cost you tens of thousands more if you draw upon that account over the course of a typical retirement.

In this video, produced by Harold Pollack and Frey Hoffman, Pollack explores the fiduciary rule and offers his advice about what those saving for retirement can do to protect their nest egg.

This is no made-up example. For decades, economists have documented biased advice provided by brokers and financial professionals to ordinary investors. Obama administration economists estimated that overly costly IRA investments cost ordinary investors in the neighborhood of $17 billion every year.

In one famous audit study, actors posed as young couples and visited storefront financial firms seeking advice. The actors met with different financial professionals and brought with them different investment portfolios. Some came loaded with stock in their own employers — the classic disastrous retirement strategy. Still others arrived with various inappropriate speculative investments. And another group arrived with low-cost index funds that matched retirement expert recommendations. They asked whether they were doing the right things and what else they needed to be doing to save for their retirement.

This is precisely the scenario in which the financial services industry might really help people, nudging novice investors into sensible and economical long-term investments. Unfortunately, researchers found the opposite pattern. Even when consumers walked in with excellent low-cost investments, most financial professionals tried to sell them inferior products that typically generate lucrative fees. This wasn’t some bad apples, either. These findings (and others) reflect standard industry practices. At least when it comes to retirement products, such behavior would be illegal under the Labor Department’s fiduciary rule, which now may never take effect.

READ MORE: You aren’t Warren Buffett. Stop trying to invest like him.

The sad thing is that financial professionals are often helpful. There’s just a basic mismatch between the way they are paid and the value they provide. Many make their money by selling dicey investments you don’t need. Yet there is great value in having a judicious outsider help you plan your retirement or your kids’ college, game out whether you are ready to buy that $300,000 home and go through your insurance. There is especially great value in a calm adviser telling you to do precisely nothing when the market plunges and you’re ready to panic and sell.

Even if the fiduciary rule were enacted, it would still only apply to retirement savings. For most other investment products, financial professionals would not be legally obligated to provide unbiased advice. Unless you’ve specifically addressed these issues, you should therefore assume you are in a sales relationship with any financial professional who offers you information or advice.

This becomes pretty clear if you have the fortitude to read the bureaucratic paperwork that accompanies most investment services.

Here, for example, is the standard word salad from Merrill Lynch:

Importantly, in providing brokerage services to you, we are not acting as a financial or investment adviser to you, as those terms are understood under the Advisers Act. Our obligations to disclose information regarding our business, actual or potential conflicts of interest between you and us, and other matters are more limited than if we had an advisory program relationship with you … [W]e may be paid by you and, sometimes, by third parties who will also pay us based on what you buy, and such compensation from third parties may be paid regardless of whether or not we recommended such security to you.

Merrill Lynch adds that you may also “receive certain additional services that are incidental to our brokerage relationship with you, such as investment and market education, research, and personalized guidance and information about financial products and services.” Over a nice cup of coffee in someone’s fancy office, it’s easy to believe she is acting as your financial or investment adviser when she provides “education, research, and personalized guidance and information.” But she’s not, within the strict legal meaning of these terms.

Fidelity offers a similarly lawyered disclosure, stating that they will offer “investment education, research, planning assistance, and guidance designed to assist you in making decisions on the various products that you may wish to hold … [but that] When we act in a brokerage or insurance agency capacity, we do not have a fiduciary or advisory relationship with you and our disclosure obligations are more limited than if we did.”

Fidelity goes on to state that were they actually in a fiduciary or advisory relationship, they would also be obligated:

  • To ensure that investment advisory services are suited to your specific investment objectives, needs, and circumstances;
  • To disclose potential conflicts of interest between our interests and yours;
  • To disclose whether and to what extent we (or our affiliates) receive additional compensation from you or a third party as a result of our relationship with you;
  • To get your consent before engaging in transactions with you for our own, an affiliate’s, or another client’s account; and
  • To not unfairly advantage one advisory client to the disadvantage of another.

When you’re operating without these ground rules, you are dealing with someone who operates on a set of incentives and legal requirements uncomfortably close to those that govern a knowledgeable car salesman. That doesn’t mean they are bad people selling junk, any more than you would say that about your local Ford dealer. Still, that obviously influences what you learn and don’t learn from the conversation.

I wish policymakers in Washington would do more to fix these problems. Fortunately, you can protect yourself without having to depend on Washington.

READ MORE: Column: Do you know how much your financial planner really costs?

The first strategy is the easiest. Simplify your investments. You just don’t need to place bets on individual stocks and economic sectors. Timing the market is a suckers’ game. A shelf full of studies demonstrates that these strategies almost never work. They are needlessly stressful, and they sucks up time and attention you should devote to your family and your day job.

You don’t need complicated investment products either. Cheap index funds outperform almost every complex investment. They’re all that most people need. Indeed, I co-wrote a book about how saving and investing is just that simple, and all of my own savings sit in a few low-fee index funds. I never mess with my investments based on today’s business page or some surprise like the outcome of the 2016 presidential election. If your only issues concern how to balance your investments over your working life and retirement, Vanguard and various robo-advisers can help you at reasonable prices.

Finally, before dealing with any financial professional, you should politely but firmly require that she agrees in writing to a fiduciary relationship with you in all of her dealings with you.

If you do consult a financial professional, it’s a good idea to use the BrokerCheck database to check that professional’s track record of ethical and legal difficulties. There aren’t a huge number of crooks out there. But due diligence remains in order. This is especially important for seniors who may have accumulated an impressive nest egg, but who have no particular training in this area. Unfortunately, unethical advisers do seek out vulnerable consumers in hotspots like Scottsdale or Boca Raton. Please don’t attend one of those free dinners at a local restaurant where financial professionals hawk annuities and related products. These are often seductive rip-offs.

Finally, before dealing with any financial professional, you should politely but firmly require that she agrees in writing to a fiduciary relationship with you in all of her dealings with you. That last part is important. Just because someone is held to a fiduciary standard in helping you with, say, your retirement account does not mean that she is acting as a fiduciary regarding the new fund for your kids’ college or for anything else.

This should not be an uncomfortable conversation. The fiduciary rule is being discussed everywhere. They’ve heard this before. It’s a huge red flag if anyone gives you a hard time or accuses you of being mistrustful for bringing it up.

READ MORE: How to find a financial adviser, step by step

There is one final bit of bad news. You may feel some sticker shock if your adviser is receiving transparent pay, and that’s coming entirely from you. You might have to pay $250 or more for an hour of a skilled person’s time. Especially if your last financial adviser was nominally free, this may sting.

When you’re feeling that sting, remember this: When something is free, you are the product. That simple insight can save you a lot of money.

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