Whose Financial Advice Can You Trust?

Asked to define fiduciary, many Americans might take a pass, especially as it applies to investment advice. (For the record, investment fiduciaries are legally bound to act in your best interest, even at the cost of their own, when giving advice or recommendations.) News that the Department of Labor might extend a fiduciary standard to everyone who advises investors on retirement accounts sent interested parties on Wall Street and in Washington into a tizzy of overblown rhetoric and accusations.

The heated debate stems from the fact that registered investment advisers are held to a fiduciary standard, but securities brokers adhere to a less-stringent, suitability rule: Investments they recommend must be suitable for you, given your goals, age, risk tolerance and so forth, but might not be, say, the lowest-cost alternative. Especially when it comes to IRAs, according to the DOL, investors taking advice from nonfiduciaries risk losing money to high fees, inappropriate investments or excessive trading because of inherent conflicts of interest. (Pensions and 401(k) plans always have a fiduciary, usually the employer, tasked with selecting appropriate investment options.)

President Obama’s Council of Economic Advisers cited independent research to quantify the risk, and headlines blared: Conflicted advice is costing investors $17 billion a year! Industry groups quickly took issue. If brokers push rollovers of 401(k) accounts into IRAs in order to reap higher fees, they’re missing the mark, says Investment Company Institute chief economist Brian Reid. He says IRA investors pay well-below-average expenses in their stock mutual funds: 0.74% of assets, compared with an overall average of 1.37%. It’s true that 401(k) investors pay even lower expenses, on average, but the increase in what you’d pay in an IRA compared with the cost of a 401(k) is just 0.16%—not the 1.10% claimed by the White House, says Reid.

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Financial industry groups warned that if small investors are forced into a fee-for-service relationship, they could pay more for retirement advice or even lose access to it altogether. “The new regulation could limit investor choice,” says Kenneth E. Bentsen Jr., CEO of the Securities Industry and Financial Markets Association, a trade group.

But the new rule would almost certainly accommodate both business models, says Barbara Roper, director of investor protection for the Consumer Federation of America. “No one has a problem with commissions or [mutual fund marketing] fees. No one has a problem with a broker making a living.” The rule could force financial products to compete on cost and quality, rather than on bounties paid to brokers, she says.

Any rule is still months away from a formal proposal, and previous efforts have been shot down. Until it all shakes out, investors should make sure they ask the right questions. “How will you make money from this relationship?” Or, “Why are you recommending this product, and what will you be paid if I buy it?” Buy-and-hold investors with little need for ongoing advice may find working with a broker to be the better value, especially if you favor stocks over funds.

Think carefully before rolling over a 401(k). If you can stay in your employer’s plan, consider taking ad­vantage of the economies of scale and lower costs that institutional accounts provide—unless investment options are poor or more limited than you’d like.