America is facing a retirement savings crisis. With millions of late-career baby boomers having failed to save enough for retirement, workers are scurrying to try to do what they can to catch up. Meanwhile, corporate pensions are severely underfunded, and many companies are shifting the burden for investing for retirement onto their workers' shoulders.
Amid this crisis, a debate has erupted recently about whether financial professionals who help people open and manage their retirement accounts should have to follow a fiduciary standard. In particular, a study from over a year ago has started getting increasing amounts of attention during the election cycle, and the arguments on both sides threaten to cloud what should be a very simple issue.
The great debate
The focus of the argument is on the impact of requiring financial professionals to follow a fiduciary standard with their clients who have IRA money invested with them. Currently, most small IRAs are held at regular brokerage companies, and brokers there typically need only make sure that investments they sell to their clients are suitable for their particular financial situation.
To analyze the impact of a fiduciary requirement, a study from Oliver Wyman looked at 12 undisclosed financial services companies and their clients. With 25.3 million IRA accounts holding $1.79 trillion in assets, the study covered a wide swath of the retirement savings in the U.S., with about 40% of the total for both categories.
The Wyman study came to some simple conclusions. If the fiduciary standard were imposed on everyone, then customers would be forced out of brokerage relationships and forced to take on higher-cost alternatives like investment advisory or "wrap" accounts. Because those accounts often require minimum account balances, those customers would have no access to advice at all. Moreover, discount brokers could find their business models unfeasible because their low-cost fee structure wouldn't support an in-depth advisory relationship. Many advisors might leave the business entirely.
A more recent study from Texas Tech challenges the idea that a fiduciary standard necessarily increases costs. The Texas Tech study looked at brokerage accounts across the country, separating them into two groups: one group for accounts governed by state laws that mandate a fiduciary standard, and another for accounts that allow a weaker standard. The study found no statistically significant difference in costs and concluded that clients ended up paying enough in additional fees to non-fiduciary brokers to offset any compliance-related costs from the higher fiduciary standard.
Fact or fiction?
Neither of these studies really attacks the heart of the matter. The simple truth is that no financial institution wants small accounts with less than $10,000. Just as Bank of America (NYSE: BAC ) and its Wall Street peers were likely happy to watch their high-cost, low-revenue free checking account customers abandon them for credit unions on Bank Transfer Day, so too would Goldman Sachs (NYSE: GS ) , Morgan Stanley (NYSE: MS ) , and other retail investment companies be happy to watch those small accounts disappear. Customers also feel considerable pressure to close those nonperforming accounts, with inactivity fees acting as an incentive to get clients to give up.
Even discount brokers don't really want tiny accounts unless they have a chance to grow into much larger ones. With E*Trade Financial (Nasdaq: ETFC ) , Charles Schwab (NYSE: SCHW ) , and their numerous discount-brokerage counterparts struggling for income in an up-and-down stock market, transaction-based income is still the most important revenue driver, and $10,000 accounts aren't going to have a lot of transactions.
Give us what we want
On the flip side, many investors don't want any mandatory standard imposed on the firms they work with. Self-reliant investors just want discount brokers to execute transactions without necessarily providing advice at all. If regulations force them to provide that advice, it just leads to higher costs that they don't want.
What it really comes down to is that any advice you get from a professional is motivated by some kind of selfish interest, if only because anyone who provides financial services needs to make a living. Just as buyers learn not to trust car salesmen entirely, the best action you can take is to figure out exactly what incentives your financial advisor has and how they might affect the advice you receive.
That's the only way you can do a gut-check on what that advisor tells you to do. In the end, you may well come to the same conclusion as I have: The best value comes from training yourself how to invest without relying blindly on outside advice.
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