Last month, President Obama gave his full support to a Department of Labor proposal that would fundamentally change how millions of American workers receive retirement advice.
While many outside of the retirement planning industry applauded the move, others had serious concerns about the outcome of such proposals. Read on to get the details -- and to see why all of this might not matter in the not-so-distant future.
Working for your best interests
The president's proposal would require all financial advisors working with retirement plans to assume fiduciary responsibilities. While many retirement advisors are already fiduciaries, they aren't required to be by law.
What's the difference? A fiduciary is bound by law to act in his clients' own best interests. For retirement advisors, that means steering money toward investments that are the most appropriate for helping a client reach his retirement goals.
A retirement advisor who is not a fiduciary isn't bound by this same oath. Instead, a non-fiduciary advisor simply needs to offer "suitable" advice, given her client's goals.
The difference between the two can be important, especially among unscrupulous retirement advisors. Too often, when a non-fiduciary funnels money into a retirement fund with high fees, there is a kickback involved that the client is unaware of.
The White House Council of Economic Advisors said the result of such conflicted advice results in a loss of $17 billion every year for working-class and middle-class families. All told, the same group said that overall investment returns are about one percentage point lower per year as a result of conflicted advice from non-fiduciaries.
That might sound like a small number, but it makes a huge difference over the long run. Consider two people -- Matt and Katie -- who start saving for retirement at age 25, and continue until age 65. For the purposes of simplicity, let's say they put away $5,000 every year, and invest in the stocks market (in reality, this number would likely increase over time to account for inflation, but the basic principal I'm trying to show still applies).
Katie has a fiduciary who guides her toward investments that are in her own best interests. Although it'll be a choppier ride than what's shown below, she has a compounded annual growth rate of 7%. Matt, on the other hand, has an advisor who's not a fiduciary, and he averages a 6% return as a result of fees and underperformance.
Here's how each one's retirement nest egg looks at age 65:
While Katie is sitting on a nest egg of nearly $1 million, Matt has roughly $775,000. What's more important than the absolute numbers, however, is the fact that over time, Katie's returns are 29% higher than Matt's.
The average person might think such legislation would be widely embraced. But that's not the case across the board.
The largest concern voiced is that the new fiduciary standard would actually limit accessibility to retirement advisors for low and middle-income families: "[The] attack on [...] so-called 'hidden fees' and 'backdoor payments' [...] has its own hidden backdoor effect -- keeping many Americans from working with the trusted advisor of their choice," said Brian Graff, CEO of the American Society of Pension Professionals and Actuaries.
Why it may not matter a decade from now
While I reserve the right to change my opinion if I see evidence to the contrary, I remain unimpressed with the doomsday predictions of those who oppose such regulation.
In the end, however, the whole debate might soon become moot because of options cropping up in the investment market that weren't available just five years ago.
Automated, low-cost, individualized retirement planning tools available at Betterment and Wealthfront offer the same type of investment advice that fiduciaries provide with extremely low fees for just about anyone -- high-, medium-, and low-level savers. These options focus mostly on passive investments with low fees, and they offer tax-advantaged and automatic rebalancing services as well.
Wealthfront, which has only been around for three years, already has $2 billion in customer assets -- many from younger workers. Betterment, on the other hand, has been around for nearly five years and has collected $1.55 billion in assets over that time.
Perhaps more importantly, traditional brokers are starting to enter the space as well. Charles Schwab (NYSE:SCHW) recently unveiled Schwab Intelligent Portfolios -- a free service that will collect fees based on the ETFs that the company offers. Simultaneously, Vanguard has been piloting a very similar program -- Vanguard Personal Advisor Services -- since 2013, with almost $10 billion in assets.
As Motley Fool CEO and co-founder Tom Gardner recently retweeted from another user: "My guess is that within 20 years, high-fee financial services will be rendered to the dustbin of history. And we'll all be better off for it."
Hopefully, such advances will reduce the amount of money being wasted on dubious advice -- and help us all save for a day when we can realize our financial independence.