Today, President Obama announced that he will be proposing a draft rule from the Department of Labor that would require those offering retirement investment advice to serve as fiduciaries. That means that they would be required by law to put the interests of their customers first—free from conflicts of interest. This is important news for everyone saving and investing for retirement. Let me explain why.
The American retirement landscape has changed dramatically since the current retirement plan rules were crafted forty years ago. Professionally managed pension plans have given way to individually managed 401(k) and Individual Retirement Accounts (IRAs). Individual investors with these accounts need help, and with more than 88 million individual investors now largely responsible for managing their own retirement assets [i], there has never been greater demand for high-quality investment advice.
The need for a new “Conflict of Interest Rule” rule is clear since potential conflicts of interest do exist in the retirement business. Financial “advisors” too often steer investors towards products that offer higher fees and commissions for the “advisor,” not what will provide the best retirement outcome for the investor. Complex fee-sharing arrangements, commission structures, and other conflicts of interest create pressures—sometimes overt, sometimes subtle—to shade recommendations in the interests of the “advisor.” Often investors are unaware that these conflicts of interest even exist. Workers end up with investments that have lower returns and higher fees, siphoning off tens of thousands of dollars in savings from the average person’s retirement account. Advisors may also have incentives to move investors from low-cost 401(k) plans to more expensive retail IRAs.
The potential harm to consumers from these conflicts of interest is significant. A 2013 study published in the Journal of Finance entitled “What do Consumers’ Fund Flows Maximize?” showed that even brokers who are unaffiliated with a mutual fund company–whom you might expect to be unbiased–steer their clients toward mutual funds that pay the brokers more, but that underperform by over 1% annually on average. While 1% might not sound like much, this annual underperformance can translate into a retirement balance that is tens of thousands of dollars lower over a 30 year career.
Defenders of the status quo argue that current conflicted business models are the only cost-effective way to get advice into the hands of smaller investors who need help.
This point of view is demonstrably false.
Founded by Nobel Prize-winning economist William F. Sharpe in 1996, Financial Engines has always operated as an independent investment advisor and a fiduciary that puts its customers’ interests’ first. We do not offer our own investment products or take commissions based on our investment advice. Financial Engines is now the nation’s largest independent investment advisor, a public company, and an industry leader managing over $100B in retirement assets, providing personalized investment advice to millions of 401(k) investors. [ii] It is important to note that half of Financial Engines customers have less than $56,000 in retirement savings. Some have as little as a few hundred dollars in their accounts.
Our experience shows there is no false tradeoff between acting as a fiduciary in the best interests of every client, and profitably serving investors with modest balances. Today’s technology allows firms to provide high-quality, objective and personalized investment advice at much lower cost than was possible forty years ago. It is not a question of doing what is right for the customer or making a profit. It is possible to do both.
To be sure, Financial Engines is not the only independent registered investment advisor. There are other successful firms and advisors that provide independent investment advice, free of conflicts of interest.
Based on our experience, financial advisors can provide independent, conflict-free investment advice, putting the interests of customers first, even when investors have smaller balances and still produce solid business results. We do it every day. By following this high standard of care, everybody wins.
We commend President Obama and the Department of Labor for taking this important step to ensure the quality and independence of the investment advice provided to 401(k) and IRA investors and look forward to continuing to speaking out on this critical topic.
[ii] For independence methodology and ranking, see InvestmentNews RIA Data Center. (http://data.investmentnews.com/ria/).