The new fiduciary standard rule has been all the rage this week on Wall Street. This new rule set out guidelines by which financial advisers must act in the best interest of their clients. Unfortunately, the new rule looks more like a lot of talk and little effective action.
The main problem with giving financial advice is that your compensation is often structured according to the products you sell. When I used to work for big financial firms back in another life I would get paid more to sell in-house products than something out-of-house. So, you wouldn’t necessarily sell a Vanguard ETF that costs 0.05% when you could sell a closet indexing mutual fund that costs 1% because you’d make more money selling the closet index fund. Because it generates higher fees the selling firm can afford to pay you more. It’s very likely a raw deal for the customer, but since we can’t definitively know that the mutual fund will be worse than the ETF then you can probably get away with this without feeling like you’re doing something that’s not in the best interest of the customer.¹
When you leave that business model you eliminate a lot of the conflicts that exist. For instance, I no longer have to worry about selling products that generate the highest fees. I worry about what’s going to keep my clients happy by ensuring that I am using the products that are in their best interest. The problem with the new DOL fiduciary rule is that it doesn’t stop this conflict. In fact, it signs off on it as A-okay because the rule slipped in a best-interests contract exemption (BICE) which will allow advisers to continue offering proprietary in-house products even if they’re not necessarily the best available option (although, of course, they’re supposed to believe they’re the best options).
In my opinion, a financial adviser or portfolio manager should look less like a car salesman and more like a personal trainer/shopper. A car salesman sells you whatever is on his lot, preferably the most expensive car. A good personal trainer/shopper constructs a personal plan for you and goes out and buys the products that will help you meet those goals. They don’t just go out and sell you the product that earns them the most money. They are experts in understanding what products will serve you best and constructing/maintaining the plan that will serve your best interest in the long-term. Over the course of my career I’ve transitioned from selling products that earn high revenues for the firm I work for to becoming an expert in the products and plans that serve my clients best.
So, how can you tell if your adviser is a fiduciary or not? Here are a few simple rules:
- Do they recommend products that consistently cost upwards of 1% or more? If so, they might not be a fiduciary.
- Do they primarily recommend products that are issued by the firm they work for? If so, they might not be a fiduciary.
- Does the adviser earn a commission or upfront fee from their product recommendation?
If you use a financial adviser you want an adviser who puts your interests ahead of their firm’s best interests. Although there’s a lot of gray area in this debate (even more so following the rule change) these simple rules will help you better understand whether your adviser is working in your best interests or someone else’s.
¹ – I am generalizing here, however, I think I am generalizing fairly.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.