Despite a shift towards more transparency in the financial planning industry, many investors still aren’t sure what they are paying their financial advisers, USA Today reported. But new rules the Department of Labor rolled out earlier this month are designed to clear things up for investors.
The long-awaited and debated fiduciary rule requires that investment advisers put their clients’ interests before their own when it comes to fees and investment choices. The new rules are designed to clarify how much advisers are paid, who they work for, and how they get paid for their work. Right now, many investors aren’t aware of ties advisers have with companies whose products they sell and referral fees and commissions they receive for selling certain products.
Conflicts of interest currently cost middle-class families, on average, about 1 percentage point lower annual returns on retirement savings and $17 billion in losses every year, according to figures from the Department of Labor.
How does the new rule change this?
Any financial adviser dispensing investment advice for retirement accounts, including employer-sponsored retirement accounts, Individual Retirement Accounts and most Health Savings Accounts, must now hold themselves to a fiduciary standard rather than a suitability standard.
The current standards work like this: investment advisers who work for broker-dealers, such as Credit Suisse, Bank of America, Merrill Lynch and Goldman Sachs, or any firms that buy and sell securities on behalf of their clients, are required to offer products “suitable” for their clients’ age, goals and income. But these products are not necessarily the best products for their clients’ individual needs. These types of financial advisers are sales representatives for their respective broker-dealers and are registered with the Securities and Exchange Commission (SEC) and with the Financial Industry Regulatory Authority (FINRA).
While these broker-dealer representatives are legally required to uphold the vague “suitability” standard, a much smaller group of registered advisers are held to a higher “fiduciary” standard. That means the financial planner must put the client’s best interests first and offer full disclosure on any conflicts of interest. Many consumers don’t realize this distinction.
When does the new fiduciary rule go into effect?
The fiduciary rule is effective on June 7, 2016, however, it will be rolled out in phases. The expanded definition of “fiduciary” will not apply until April 10, 2017.
Which financial advisers do the new rules mostly impact?
Reporters who want to dig into how the new rules will impact advisers should educate themselves on the different industry players. All financial planners get paid for their services, but two main payment structures exist in the industry: “fee-only” and “fee-based.”
Fee-only financial planners charge their clients either an hourly rate or flat rate, or a fee based on a percentage of a client’s total assets under management – usually about 1 to 2 percent. Nearly all fee-only financial planners already are held to a fiduciary standard, and the new rules will not likely impact them. Any adviser certified by The National Association of Personal Financial Advisors is fee-only, adheres to a fiduciary standard, and agrees to a peer review of his or her financial planning. That’s also true of advisers who hold the Certified Financial Planner designation. Advisers who are designated CFPs by the Certified Financial Planner Board of Standards adhere to a fiduciary standard and have passed a rigorous financial test. They must also keep their license up-to-date by taking periodic refresher courses.
Advisers who operate under the fee-based payment model are most likely to be impacted by the new rules. Fee-based advisers tend to charge based on a client’s assets under management, but they may also receive commissions and additional fees, which typically range from 3 to 8 percent, for selling certain products, including insurance, annuities and other investments like mutual funds. At times, this system creates conflicts of interest. Planners compensated through commissions and other fees have incentives to sell products that drive higher earnings, not necessarily the best fits for the client’s needs.
How does the new rule impact investors not meeting minimum account thresholds?
While it is true that most fee-only financial planners currently tend to cater to wealthy investors, experts still say the new rules will be positive for all consumers. The average investor should see their cost go down over time and can better trust their financial adviser.
Those who don’t meet minimum account thresholds for traditional advisers may want to consider advisers who charge a flat, hourly fee, rather than an asset-based fee, Liz Davidson, CEO of financial education company Financial Finesse, told USA Today. Davidson also told USA Today another option is “robo-advisers that typically charge lower fees and have lower asset minimums.”
A few questions to ask financial advisers when reporting on the new rule:
- What is your current compensation model?
- Do you plan on changing your model because of the new rules?
- Will you change your business model because of the fiduciary standard?
- Will this change who you hire?
- How will this impact your bottom-line?
- Critics of the draft fiduciary rule said it was too complex and could raise compliance costs for broker-dealers, potentially making advice more expensive for middle-income investers. Do these critics still feel the same way about the final version?
