No, today’s post is about your own independence from the biases that are infused into advice you might receive from an advisor who is working for an insurance company, a brokerage, a bank, or a mutual fund company.  The way you can achieve this independence is to work with an independent advisor – an advisor who operates as a fiduciary, providing advice that is solely in your own best interest.  This is an important enough issue for me to direct you to other advisors’ websites – folks who technically are competitors to me – so that you can see what they have to say about this independence and the fiduciary duty of care that you, the consumer of financial services, deserve.

So, today I am highlighting several colleagues of mine who are independent financial advisors – and providing links to articles they’ve written about independent advice and the fiduciary duty that they engender.

For starters, Roger Wohlner, CFP®, a financial advisor based in Chicago, wrote the article “2010 The Year of the Fiduciary?”.

Nathan Gehring, CFP®, EA, who is running a financial advisory out of Appleton, Wisconsin, recently wrote about the fiduciary “fight” that has been going on in Congress as a part of the financial industry overhaul legislation in his article “Forget the Fiduciary Fight”.

Based in Atlanta, Georgia, Russ Thornton recently wrote an article entitled “Do Commissions Influence Your Advisor?”, which details some of the ways that you may be getting short-changed in the advice you receive.

And while we’re talking about advisors in the Peach State, Teri Tornroos, EA, CFP®, wrote the article “How is Your Financial Advisor Paid?”, giving you insights into the issues of commissioned advisors versus independent advice.

Jean Keaner, CRPC, CFDP, an independent advisor out of Keller, Texas, wrote an article announcing that “Motley Fool Endorses Garrett Planning Network”.  The Motley Fool, one of the most admired financial brands in America, has exclusively endorsed the Garrett Planning Network, a fee-only financial planning network whose members operate as fiduciaries for their clients.

Last but not least in my list is Curtis Smith, CFP®, who operates his fee-only financial advisory out of Sugarland, Texas.  Curtis recently wrote the article “Why People Want Independent Financial Advisors”.  More good information here about why you should choose an independent advisor to bolster your own independence.

If you’re looking for an independent advisor you can go to the Garrett Planning Network’s website and use the “Locate an Advisor” page to find a planner near you.  Another option is to go to the NAPFA website (NAPFA stands for National Association of Personal Financial Advisors) and use the “Find An Advisor” tool there.  No matter how you do it, you owe it to yourself to declare independence – and use these independents’ resources to help you do it.

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Today, my friend and colleague, Steven Young, CFP®, has graciously provided a guest post, giving us his thoughts on the fiduciary standard of care.  Steven operates his Fee-Only financial planning firm, Steven Young Financial Planning, out of Springfield, Missouri.

A fiduciary is required by law to act in his or her client’s best interest at all times.  What you may not know is that the vast majority of those who call themselves “financial advisors” or “financial planners” are not actually subject to a fiduciary obligation.

Under current rules, advisors who are compensated by commissions on the sale of financial products are subject to a lesser standard known as the “suitability rule.”  This regulatory hurdle requires only that the product sold be appropriate for the client (in other words, not too risky) at the time of sale.  In fact, these “advisors” can now sell you products that pay them bigger commissions, without advising you that there might be a far better (and cheaper) alternative for you – it just wouldn’t be as good for them. Moreover, this suitability obligation ends once the transaction is completed.

Registered Investment Advisors that have either registered with the SEC or the state in which they do business do have a legal fiduciary duty to their clients.

One of the most important questions you can ask of anyone offering you financial advice is, “Do you have a legal obligation to act in my best interests?”

It is the bright white line that separates those who sit on your side of the table and have a legal obligation to act in your best interests and those who sit on the other side of the table and have no such obligation.

Members of the Fee-Only Financial Advisory community firmly embrace our role as a fiduciary for you.  This is not just a regulatory requirement imposed by law; it is part of our culture. Operating as Fee-Only firms to fulfill this role eliminates the conflicts of interest that may arise when advice is delivered through commissioned product sales.

To help educate consumers about the importance of the fiduciary relationship between advisor and client, the National Association of Personal Financial Advisors (NAPFA) hosts a website which provides information about the need for a fiduciary standard in the financial services industry as well as a checklist consumers should use in evaluating their own advisor.

If your friends and family are not working with a fiduciary advisor, please share this information with them.

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For lots of folks, we’d almost rather spend time in the dentist chair than gather all of those statements together, along with our previous plans (if we have any), and do a thorough review of where we are, where we’re headed, and if we’re on track for our goals – retirement being the goal of foremost importance to most.  Yes, we may have gone to a financial planner and talked over our financial situation, then implemented well… some of the recommendations.  After that, we put the plan documents on the shelf and have pretty much forgotten about it.

Things Change

As time passes by, things have a tendency to change – and that change is likely to have rendered your financial plans (you do have a plan, right?) hopelessly out of date.  Remember how your financial planner pointed out that the plans you discussed were only a “point in time” review?  And how the projections and recommendations would only be good for a short period of time?

Perhaps you’ve changed jobs, had a new addition to your family, or moved to a new home.  All of these things will have had an impact on your financial situation, for sure.  Have you gone back and reviewed your plans to include the changes?  Have you adjusted your insurance coverage to account for the new child?  Have you rolled over the 401(k) plan from your old employer?  These are all things that you need to do to maintain your financial life.

Maybe you’re thinking about putting into motion that Roth IRA conversion plan that you and your planner discussed a couple of years ago.  Some of the tax laws have changed since then, have you factored that into your plan?

Final Thoughts

I’m not saying you need to camp out on your financial planner’s doorstep any time something changes – many folks get along just fine in a “do it yourself” mode.  But if you’ve (wisely) chosen to utilize the services of a financial planner in the past and it’s been more than a couple of years – it would likely be well worth the effort to get back together and do a review.  This is especially true if you’ve had any major changes in your life, such as retirement or changes to your family.

And if you don’t already have a working relationship with a Fee-Only financial planner, you can always find one at the National Association of Personal Financial Advisors’ website, or the Garrett Planning Network’s website.  Both websites feature “Find a Planner” maps that can help you to locate an advisor to work with.  And of course you could always just give me a call if you like.

The point is that it makes sense to update your planning information – even if that just means developing a spreadsheet and tracking your savings, debt reduction, spending habits, and goals.  Without regular “checkups”, things can go awry for you without your knowing about it – and waiting too long between checkups can make small problems much larger that necessary.  So do yourself a favor and get a checkup!

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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

The fiduciary standard has long been sought after by consumer advocates, as the great majority of financial professionals are held to a much lower standard of care – one that often leaves the consumer of financial services exposed to higher costs and a low likelihood of advice being in his or her best interests.  Last year, proposals were offered in Congress to require the fiduciary standard of all regulated financial professionals – which is a step in the right direction.

However, intense lobbying efforts by the fatcats, the heavyweights of the financial services industry (think banks, brokerages, and insurance companies) has just about killed the concept of an industry-wide single standard altogether.  The original proposal by Senator Dodd (head of the Senate Banking Committee) that was to require a fiduciary standard across the board has been withdrawn due to intense opposition from lobbied members of the committee.  Now the committee is working on a compromise, which is not likely to carry the same requirement.

WHY?

You’ve got to ask yourself – Why?  Why is it so important to these companies that their sales forces are not held to a standard of fiduciary care?  After all – the fiduciary standard requires that advice given is in the best interest of the consumer.  Who could be against something like that?

If you look at the industry makeup, you’ll get a clue:  90% of the members of the financial professional industry are not held to a fiduciary standard, and much of the remaining 10% are small, independent firms, not backed by large marketing budgets.  The reason becomes clear when you think about where the money is – it takes a lot of hard work to provide a fiduciary level of care, and as a result it can be costly to provide, and therefore difficult to justify.  It is much more lucrative (and cost-effective) for these companies to provide one-size fits all solutions to masses of clients, especially if you don’t have to care if the solution is in the best interest of the client.

When there are billions of dollars annually at stake, it’s not hard at all to understand why the lobbying effort against the fiduciary standard is so intense.  If this standard were to come into being, current sales techniques would have to be totally re-tooled, and likely the vast majority of the existing sales force would have to be replaced, due to increased training required to adequately provide the level of care that the fiduciary standard will necessitate.

So what can you do?

As consumers of financial services, we all owe it to ourselves to remain diligent – to understand the requirements and standards that our financial professionals are held to.  Just because Congress isn’t up to the challenge of requiring a fiduciary standard of all financial professionals doesn’t mean that you have to swim with the sharks.

Know that your insurance guy, the broker down the street, and those bank employees are only required to provide you with “suitable” solutions, not solutions that are in your best interests.  That’s not to say that you will never get a good solution from these folks – most often the non-fiduciary guy or gal truly wants to direct you to the right solution.  But if a choice comes down to selling you a product that’s suitable versus pointing you to a solution that’s in your best interests but doesn’t pay off for him or her… it’s not hard to imagine that the product sale would win out most of the time.

Instead, seek out a true fiduciary, Fee-Only, CFP® professional to get your advice from.  (You can start your search at www.NAPFA.org, the National Association of Personal Financial Advisors.)  Those other guys are salesmen – go to them specifically to buy your insurance products, investments, and the like – but get the advice of a fiduciary advisor first.

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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

I recently read a very good article that echoes a sentiment I’ve written about before:  this article speaks to how the 401(k) plan is one of the places that the average Joe Employee is getting ripped off – you can see the actual article here, and I’ll summarize below.

The 401(k) Dirty Little Secret

Without getting too technical about all this, the problem is that most 401(k) providers are able to get away with supplying a plan that is high in cost when compared to the rest of the marketplace, with no one but the plan participants (read that “employees”) bearing the brunt of the cost.  And furthermore, the plan participants have little to no say in making changes to the plan in their favor.

Since there is no legislation to make true fiduciary responsibility a requirement – meaning that the plan provider must act in the best interests of the plan participants – most often the plan and the investment choices are among the highest internal cost investing options available.  Since the way the fees are charged is totally at the back end (at the mutual fund company, usually) and the employer sees little or no up-front costs, the employer is happy with the plan.

In addition, the mutual fund company is thrilled to have a captive audience with only their funds available to be invested in – which translates into new deposits for the company for nearly no marketing cost.  And of course the agent who sells the plan is ecstatic:  for literally no ongoing effort, he is able to rake in a percentage from each and every dollar that goes into the plan.

However – the tide may be turning in favor of the employee.  As indicated in the article, a recent Eighth Circuit Court of Appeals decision held that there was merit to the complaint that WalMart’s 401(k) plan included high-cost funds when lower-cost funds were available, and that subsidies given to the plan’s trustee could be in violation of ERISA law.

We’ll keep watching these developments, as this could be a major turning point for 401(k) plan participants.  Hopefully this is just the start of good news for employees, who have continuously been given short shrift with regard to retirement plans.

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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

What’s the Difference?

You’re probably wondering – what’s the difference between a broker and, for example, a fee-only advisor?  You’re right to be confused, because until you start working with one or the other and you know what the difference is, they look pretty much the same from the outside.  Here’s the difference:

Brokers are salesmen. It is their job to sell you an investment product, and that’s how they get paid.  They are required by law to ensure that the product is “suitable” to your situation.

Fee-only advisors are advisors. Fee-only advisors are bound by law to act as a fiduciary.  It is their job to advise you on the appropriate strategies and tactics – investment moves that are in your best interest.

That’s a pretty big difference in itself – but since that differential makes the fee-only advisor look SO much better (and since this writer is a fee-only advisor), I wanted to point out what research has born out to be true about the recommendations that you get from a broker.

What Can a Broker Do For You?

There is a study done by researchers at Harvard and the University of Oregon (Bergstresser, Chalmers, and Tufano), which strives to identify the possible benefits to the consumer of financial services in purchasing investments via a broker. They looked at five possible benefits:

1. Assistance in selecting funds that are harder to find or evaluate.
2. Access to funds with lower costs excluding distribution costs.
3. Access to higher performing funds.
4. Superior asset allocation.
5. Attenuation of behavioral investor biases (in other words, saving the investor from himself)

Ultimately, the researchers “found it difficult to identify the tangible benefits delivered by brokers.”  But that’s getting ahead of ourselves.  We’ll take each category separately and briefly describe the findings.

Assistance in selecting funds that are harder to find or evaluate

It is true that brokers often direct investors into smaller, younger funds that have less track record or are not covered by major rating services.  The costs (especially in time) to the individual would be enormous in researching these funds. If the other benefits are brought about by utilizing these harder to find or evaluate funds, then there would be a benefit to working with the brokerage.  What we’ll see is that the rest of the evidence doesn’t bring that conclusion.

Access to funds with lower costs excluding distribution costs

The researchers found that the funds sold through the broker channel do not have lower costs excluding distribution fees.  In other words, even if funds exist that are of a lower cost, the brokers are not (in general) directing investors to those funds.  Across the board, the annual cost of a brokered stock fund was on average 2 basis points (bp) higher (.02%), not including commissions or 12(b)1 fees.  And the average annual cost of a bond fund was an amazing 23bp higher, and money market funds were on average 4bp greater.

Access to higher performing funds

The overall return, as well as the risk-adjusted return, is lower for the funds that the broker chooses, versus funds that are directly purchased via other channels (e.g., a fee-only advisor or through personal research by the investor).  Stock funds underperformed direct-purchased funds by an average of 7.5bp (.075%) – and using risk adjustments caused these figures to get even worse.  Bond funds underperformed as well, but money market funds did provide a slightly better return, by a total of 18bp on average.

Superior asset allocation

While a broker’s asset allocation recommendation is different from that of other investment channels, over time the outcome is pretty much the same for either type of investor.  The difference is that, on average, the broker tends to direct a higher percentage of investors into bonds (as opposed to stocks).  Since stocks, over a long run, outperform bonds and bonds demonstrate lower risk (as measured by standard deviation), this difference in allocation weights tends to even out between the two.

Attenuation of behavioral investor biases

Lastly, the research shows that most broker-driven investors are much more sensitive to short-term performance in the market than other investors.  This leads to “performance chasing”, which in general does not bear greater returns, while at the same time increases incremental transaction costs.  Transaction costs benefit the broker, of course.

But wait, there’s more!

In addition to the research summarized above, you need to know about how a broker is typically paid.  I already mentioned that the broker is paid to sell the investor products – how does that work?  There are many types of fees which can impact an investor’s account:

• Front end loads: this is a commission charged when you purchase the fund.  Typically these can be anywhere from 3% to 5% or more of the purchase, although at much higher balances the fees can be reduced and even eliminated.
• Back end loads: this is a commission charged when you sell the fund.  Often, this is used to keep an investor in a fund for a specific period of time, during which other fees can be transacted from the account.  After a period of time, these back end loads are waived.
• Annual loads:  this is an annual commission based on the holdings in the account, and can be one of the most expensive ways to hold investments.
• 12(b)1 fees: this is also an annual fee based on the holdings in the account, and often is the most elusive to identify – while representing the greatest drain to the investor.  This fee is usually pretty small in relation to other fees (sub 1%) but it is charged across all classes of funds, whether a front-end, back-end, or annual load.  What really hurts is that the 12(b)1 fee is specifically for marketing the underlying investment.  In other words, as an investor in the fund, you’re paying to help bring in more investors.

While it’s not conclusive, some of the results found in the research paper indicate what you might expect:  that brokers sell the investments that pay them the most.  For example, as the front-end load or 12(b)1 fee increases for a particular fund, there is an attendant increase in the sales of the fund.  Not unexpected, it’s basic human nature.

Conclusion

The research shows no tangible benefit to working with a broker – in fact, results are often worse with a broker.  Add to that the costs of working with a broker, above and beyond the dismal results that you achieve, a conclusion isn’t hard to come by:  it makes more sense to either do the research on your own and purchase funds directly, or to work with a fee-only financial advisor who will do the research and operate as a fiduciary to ensure that the investment choices you make are in your best interests.

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“The reality is that the brokerage firms are set up for the brokerage of products,” says Ms. Rosenband (a former Smith Barney rep). And even though brokers’ titles may have changed over the years to “financial advisers and consultants,” she says the culture at the firms hasn’t. As a result, clients were often confused about what they were getting, she says, adding that she brought over about 20% of her clients, mainly those who were primarily interested in a long-term approach.

I agree with the article, the average investor/saver/future retiree can definitely benefit by utilizing an independent fiduciary advisor over a brokerage sales rep.  I just hope this message is getting out to enough people to make a difference.

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It should not come as a shock that there are certain costs involved in maintaining a 401(k) plan – there is a degree of back office activity, such as signing up participants, tracking accounts, maintaining changes to accounts, distributing statements, and the like.  In addition, the plan administrator must provide certain reports to the government, along with required annual reports for participants (that annual Summary Report, written on tp, that you get in the mail once a year and promptly toss in the trash), as well as reports to the management of the sponsoring company on plan participation rates and such.

You would likely expect to share in the cost – after all, it’s benefiting your account, right? – and it seems like that sharing should be based on your account balance or at best evenly distributed among all participants.  However (and there’s always a however in life)… depending upon your fund choices, you may be paying more toward those back office activities than the guy in the cubicle next to you.

Turns out, the more inherent fees in an investment choice, the greater portion of the overhead you’ll be taking on (in general).  If you’re in a money market account or (shockingly) the company stock, you might not pay any overhead.  If you are in a managed mutual fund, you could be paying as much as 0.6% in annualized overhead fees.  As with most things surrounding 401(k) fees, it’s not very clear just how these costs are allocated – and quite likely not very fair in the long run.

Hopefully the Fair Disclosure legislation will find appropriate legs and make its way to law, giving us all a much-needed view into the costs of our plan choices.  Well, we can hope, right?

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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

• Reducing Automatic Enrollment. The argument here is that, the more people that are participating in the plan, the more it will cost the employer, in terms of administrative fees and matching dollars.  I think this is pretty short-sighted, personally, since the employer is impacted by lower participation as well.  When lower-paid employees are not participating at a high enough rate, the highest paid employees (the owners, in most cases) are limited in rate of participation in the plan.  I think that the costs could be reduced across the board by looking to lower fees and inherent expense ratios in the plan, among other efficiencies (some of which are listed later).
• More Hand Holding. I think this is a very good idea, as many (most!) folks have little to any clue about what should be driving their decisions with regard to investment choices.  Additional help provided by the employer is a good idea – and if the coming legislation requiring this assistance to be fiduciaries is enacted, employees will be assured of receiving advice that is in their own best interests.
• Reducing or Eliminating Employer Match. While this is a big benefit, if it doesn’t make sense to the bottom line, then the employer has to make tough decisions like this.  I wouldn’t expect to see this happen on a long-term basis – it’s a strategic benefit that most employees expect.
• More Online Services. In today’s world, the efficiency and cost/benefit of this is a no-brainer.  If it irritates you to get an electronic statement instead of a paper statement, you need to join the 21st century.  If you simply have no means of receiving an electronic statement, you get a pass on this one, although this should be a small percentage of folks I’d think.
• Lower Fees. I think this one makes a lot of sense in the long run.  Fees and expense ratios are the biggest drag on investment returns that most 401(k) investors face, so for the employer to concentrate on providing low-cost alternatives is a wonderful move.  Seeking out the lowest fee custodians only makes sense as well – and could likely make up the difference in expenses noted in the first bullet point. Increasing participation should drive down costs in the long run.

So that’s my take on the story, what do you think?

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The wonderfully-named Conflicted Investment Advice Prohibition Act of 2009 reckons to disallow conflicted advisors (those who are beset with conflicts of interest in providing advice) from providing employer-sponsored advice to 401(k) plan participants.  Namely, those advisors who stand to benefit personally in terms of compensation from the counsel that they might provide to 401(k) plan participants.

This is very important legislation because earlier this year, the Department of Labor completed a ruling that gives permission to the brokerages and investment houses to provide advice to 401(k) plan participants (this was a clarification of a law set forth in the Pension Protection Act of 2006).  The advice that they provide represents major conflicts of interest for the participant, since the advisor stands to benefit from various choices made with the plans.

While I believe it would be beneficial to the 401(k) plan participant to have investment advice available to them as they make decisions about their investments, I believe that conflicted advice doesn’t fit the bill.  The appropriate advice would be independent of compensation-oriented conflicts of interest – meaning the advisor is not related to the custodian and receives all compensation from the participant or the participant’s employer. Period. Oh yes, and the advisor should act as a fiduciary on the participant’s behalf.  Not too much to ask, don’t you think?

Look for more updates as this legislation moves its way through.

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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).