By now, even casual consumers of the financial media have likely read several articles on the new fiduciary standards being mandated for advisors that work with client retirement accounts.
But the new rules leave open many questions as to what investors should actually expect in terms of account changes due to the new rules. First, a warning: just because your advisor must now act as a fiduciary, meaning in your best interest and not his or his employer's, that does not necessarily mean that short-term account performance will dramatically improve.
The fee-based registered investment advisor business model really took off in the early 1990s. RIAs and their investment advisors' representative are required to always act in their clients' best interest for all accounts, not just for retirement accounts. While a fiduciary standard is a good reason to choose an RIA to work with, that doesn't mean that RIAs have a significantly better investment track record.
There is not a very short list of investments that are "good" and everything else is high-fee garbage that will simply go away. There are more than 10,000 listed stocks, 30,000 mutual funds and who knows how many UITs, index-linked CDs, private placements and others. Not all of these exist just because of good marketing -- many offer valid investment opportunities.
And despite claims to the contrary, timing does matter. Individual investment accounts are just as likely to underperform as to overperform expectations. Being a fiduciary does not grant a license to operate your own crystal ball. The investor still needs to be aware and perform some basic due diligence before choosing an advisor when investing their hard-earned funds. A good advisor or broker will remain a good advisor or broker. And hopefully the minority of bad brokers and the bad products they sell will leave the industry.
What is likely to happen to investors' benefit is a consolidation of mutual funds around a consistent fee structure. Steele Systems, using data provided by Morningstar, has 30,243 mutual fund records in its database. That does not mean there are that many different mutual funds. For example, the American Funds Group, a popular choice among brokers, lists 18 pricing structures for the same fund!
If you are investing in American Investors Fundamental Investors (ticker: ANCFX) via a 529 plan, you could be paying a front-end load of 5.75 percent, annual expenses of 0.7 percent and a 12b-1 load of 0.22 percent. Or you could just be paying annual expenses of 0.48 percent with no loads or back-end surrender fees. That is a big difference. Retirement plan investors could be paying as much as 2.4 percent annually or as little as 0.31 percent, with six additional choices in between.
While American Funds will say that the reason for the difference is that the higher fees are necessary to recoup costs for smaller plans, there is nothing in their application that requires brokers to offer low-cost versions for larger plan balances. Lest we paint the load or broker-sold funds alone into the bad-guy corner, consumer favorite Vanguard also offers multiple fee structures. The Vanguard Developed Markets index fund (VTMGX) is offered in four payment plans. Vanguard is more consistent in that their lower-expense funds become available to larger accounts and their overall cost structure is very low.
Over the long run, these fee differences make a significant difference. And this is what the new rules focus on, along with adequate disclosure. For example, the Wells Fargo Index A Fund (WFILX) is the same fund as the Vanguard S&P 500 index fund (VFINX) as they both replicate the Standard & Poor's 500 index. The Wells Fargo offering has a 0.56 percent annual expense and can cost up to a 5.75 percent upfront load, while the Vanguard retail offering has an expense of just 0.17 percent with no additional load. And its exchange-traded fund (VOO) is cheaper yet, with just a 0.05 percent expense ratio.
The new rule doesn't necessarily mean that American Funds will consolidate from 18 to a single cost offering, or that Wells Fargo will necessarily stop offering an index fund. What it means is that if you are invested in a higher-expense share class or company with higher expenses, there needs to be a reason why.
For index funds, it is hard (even impossible) to rationalize a higher expense ratio from one fund to the next. Actively managed funds are a little trickier. You do need to look at risk, strategy and multiple returns over time. But the point is that fees and conflicts of interest must now be openly disclosed, and justified based on the merits to the investor.
That's something RIAs have been doing all along. Now there is just a level disclosure playing field.
William DeShurko started in the financial services industry in 1987 and formed his own practice in 1994. He is a portfolio manager for Covestor, the online investing marketplace, and owner of 401 Advisor, LLC a registered investment advisor in Centerville, Ohio. After following fads, phases, and products of the day for nearly 30 years, he hopes that his insights and experience can help today's investors navigate the financial markets. You can read more of his insights at www.deshurkoblog.com or contact him directly at firstname.lastname@example.org.