If you are not a part of the financial industry, you are probably unaware that this past spring the Department of Labor finalized the fiduciary rule. The fiduciary rule will hold all financial advisors who provide retirement investment advice (401(k), IRAs, IRA Rollovers, etc.), to a “fiduciary standard” – or in other words, require them to put their client’s best interest above all else. This new rule is expected to take effect in April 2017. It is noteworthy that the new rule does not apply to after-tax investment accounts, even if the after-tax account is earmarked for retirement.
This issue may seem obscure to most individuals, but I believe it is one that every investor should be aware of and care about. The Department of Labor claims that investors will save billions of dollars annually in exorbitant fees as a result of this new rule.
How exactly does this new rule save investors fees? Currently, many providers of investment advice follow a lesser standard, called the “suitability standard.” This standard means that although a particular investment may not be in your best interest, it is deemed suitable for someone in your circumstance.
In real life what does all of this mean? It means that under the suitability standard an advisor who has a client with $1.2 million in a retirement account and looking for yield and income could put half of that client’s retirement account in a nontraded REIT. The advisor’s commission on the product, unknown to the client would typically be between 5 and 10 percent or between $30,000 and $60,000. Under the suitability standard it would be acceptable to sell this product to the client without disclosing fees. Under the new fiduciary rule the advisor can still sell the nontraded REIT to the client but the advisor will have to meet the requirements of the “Best Interests Contract Exemption” which includes fee disclosure and reasonable compensation parameters and could make it a tougher sell. As a side note, if you are being approached to invest in a nontraded REIT, be aware of the liquidity issues related to nontraded REITs and research rather or not a publically traded REIT fund would be in your best interest.
As I mentioned above, the new Department of Labor fiduciary rule only applies to retirement account advice. Therefore, in the above example, if the client’s $1.2 million was in an after-tax account it will still be okay to sell the nontraded REIT to the client without disclosing the large commission to be received. However, if you are interested in an advisor who must adhere to the fiduciary standard with regards to both your retirement accounts and your after-tax accounts you should learn more about Registered Investment Advisors. All Registered Investment Advisors have operated under the fiduciary standard with regard to both retirement investment accounts and after-tax investment accounts since the 1940s.
What is the take away and why should you care? Surveys show clients are nearly clueless as to what the word “fiduciary” means. In fact, our firm has been told not to “clutter” our marketing material by using a term that people don’t care about or understand, but I believe that it is important that you understand what it means and when your financial advisors is acting in your best interest.
The Department of Labor fiduciary rule represents a positive change for the industry, but doesn’t eliminate the investor’s responsibility to be educated. Well informed investors are better equipped to choose the best advisors, ask the right questions and stick to their financial plan. I believe it is important that you understand the difference and care about which standard your advisor is bound to, the fiduciary standard or the suitability standard.
Terry L. Roe is a financial advisor with Onyx Financial Advisors, LLC an independent fee-only registered investment advisory firm located in Idaho Falls, Idaho. He can be reached at (208)522-6400 or www.OnyxFinancial.com