The assault on the fiduciary rule
Even before the review of Dodd-Frank gets going, Trump has gotten financial policy badly wrong. At the same time as issuing the executive order, he also took a step toward canceling the fiduciary rule for financial advisors that is scheduled to go into effect in April. The fiduciary rule says that professional financial advisers, in return for their fees, must put their clients’ interests first when advising them on assets invested through retirement plans (such as Individual Retirement Accounts and 401(k) plans). The motive behind its cancellation could not be to help the average American family, because it would so clearly have the opposite effect — like a number of other Trump policies.
The fiduciary rule was adopted, after extensive review and preparation during the last years of the Obama Administration, for good reason: many investment advisors and brokers have a conflict of interest that incentivizes them not to act in the best interests of their clients. Typically they recommend a stock or bond or fund that is not quite as good as others, but for which the adviser receives a hidden commission or de facto “kickback” for recommending. It may be the firm’s own product. Many investors don’t realize that the adviser is not legally obligated to do otherwise. The end result is underperformance of the savers’ retirement accounts. They have no recourse if they discover the truth too late, e.g., when they are ready to retire.
What is the main argument against the fiduciary rule, beyond an apparent desire to maximize profits for financial institutions? It is a claim that the rule is a case of government over-reach, because it deprives families of some choices that they would otherwise have. But this argument disregards the reasons that savers seek a financial advisor in the first place.
How do savers approach their investment strategy?
There are, broadly speaking, three approaches to allocating one’s assets. First, if one believes that one has judgment superior to that of the average investor in the marketplace, one can actively choose which individual assets or which actively managed funds to buy and sell. Such investors distill information on their own and have no need for a retirement savings advisor. There is a huge variety of financial assets, products, and funds that they can freely partake of if they wish, especially in the Anglo-American countries.
Second, one can put one’s money in broadly diversified low-cost funds, such as the index funds offered by Vanguard, and leave it there. This is the approach most economists recommend, because it delivers higher returns than the first approach. Most investors who follow the first approach buy and sell too often, eat up a lot of money in cumulative transactions costs, and are unrealistically optimistic about their abilities to pick winners or to time the market. (The category of investors who in fact merit the belief that they can systematically beat the market may consist of only one person, Warren Buffett.)
Regardless, under the second approach there is again no need for an advisor, unless one counts the advice one gets from reading a paragraph like this one, which is free. Recommended allocation shares within the person’s total financial wealth are something like 60% in equities, 30% in bonds, and 10% in money. (The precise shares depend on the individual’s preferences, particularly his or her degree of risk-aversion and the likelihood of needing cash for a major upcoming expense. Within equities, perhaps one-third should be foreign.)
The superior track record of the index funds has gradually attracted more and more investment dollars over the years. Still, many small investors just can’t bring themselves to believe that the second approach is the best they can do, and yet they recognize that they don’t have the time or skills or interest to pursue the first approach. These are the people who seek an investment advisor. They want someone they can talk to about their portfolios, and they want it to be someone they can trust. The word “fiduciary,” like “fidelity,” comes from the Latin for “trust.” The advisor is of little use to them if he or she cannot be trusted to give advice in the investors’ best interests.