For decades, millions of investors have fundamentally understood the nature of their relationship with their financial advisor. While most people expect brokers and other investment professionals to act in their clients' best interest and to make prudent decisions while avoiding conflicts of interest and self-dealing, only a limited number of financial advisors are actually bound by the guidelines that define the fiduciary standard.
For years, The Motley Fool has informed investors about the need for a uniform fiduciary standard and the dangers of conflicts of interest between brokers and clients. Delays have thus far prevented implementation of a broad-reaching fiduciary standard, but a recent study makes it clear just how much those delays are costing investors.
The cost of waiting: $1 billion a month
Last week, an article in Fiduciary News examined some recent academic research that sought to answer the SEC's call to quantify the costs of not having a fiduciary standard. The most recent paper, which came from researchers at the University of Texas at Austin and Indiana University, concluded that 401(k) plan trustees that have conflicts of interest were more likely to hang on to bad-performing fund options than were trustees without such conflicts.
That's not all that surprising when you consider how the 401(k) industry works. Fund companies and other money managers often act as trustees of 401(k) plans, and they clearly have huge incentives to keep offering their own funds rather than those of competitors, even when alternatives perform better. Moreover, with employees locked into those 401(k) investment options, they have little choice but to accept the underperforming fund choices those trustees pick.
But what is surprising is the extent of the underperformance. The researchers found that the lowest 10% of funds underperformed by 3.6 percentage points annually, compared with investments with similar risk profiles. Fiduciary News then did the math and concluded that with more than $10 trillion in retirement assets, the cost of that underperformance is $12.3 billion per year -- more than $1 billion each month.
A collective yawn from Wall Street
Meanwhile, broker compensation continues to center on the same incentives to gather assets and drive revenue. As Fool contributor Molly McCluskey examined late last year, Morgan Stanley (NYSE:MS) recently implemented changes that would reduce the bonuses that their investment pros receive and give them incentives to take bonuses in restricted stock subject to future vesting rather than cash. More generally, brokerage firms have been more eager to define compensation arrangements since Bank of America (NYSE:BAC) got sued by former Merrill Lynch brokers over allegations that the brokers missed out on deferred compensation and retention bonuses that they argue they were entitled to receive.
Moreover, during tough economic times in the industry, when movements of brokers from firm to firm get more common, clients can face unexpected financial devastation from following their brokers. Many companies charge exit fees for transferring accounts to other brokerage firms, and with some proprietary funds not eligible for transfer to outside firms, the need to sell off existing assets and buy new ones -- at a brand-new commission -- can be extremely costly.
Overall, stories such as former Goldman Sachs (NYSE:GS) employee Greg Smith's book criticizing the company only accentuate the feeling that clients have that they're only revenue sources for their advisors. Several discount brokerage companies, including E*TRADE Financial (NASDAQ:ETFC), Charles Schwab (NYSE:SCHW), and TD AMERITRADE, have sought to expand investment advisory options to take advantage of that bad view of Wall Street brokers, but it remains to be seen whether they'll avoid making the same mistakes in letting self-interest win out over clients' best interests.
Don't wait any longer
Regulators need to work faster to get a universal fiduciary standard in place to protect unknowing clients from their conflict-ridden investment professionals. The cost of waiting is simply too high.
Fortunately, you don't have to wait for a universal fiduciary standard. By demanding an investment professional who voluntarily adopts such a standard, you won't get guaranteed winning results, but it should make you feel more comfortable about the advice you get from the person you're depending on to help you reach your financial goals.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter: @DanCaplinger.
Fool contributor Dan Caplinger owns warrants on Bank of America. The Motley Fool recommends Goldman Sachs and TD AMERITRADE and owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.