The more you learn and the more expert you become, the more you realize how little you know…
Words like trust, reliable, and fiduciary communicate safety and security. When consumers hear fiduciary, they expect optimal solutions that represent the best possible advice available. When dealing with matters of life and death, the assurance of working with a fiduciary provides peace of mind since, presumably, all solutions within human capacity will be evaluated for their merit before recommendations are provided. The assumption is that the fiduciary has the competency to evaluate the plethora of options.
Since medical, legal, and financial advice directly impacts their lives, most individuals want advice from someone who is held to a fiduciary standard. Medical doctors and lawyers have always worked as fiduciaries. In terms of financial advice, retirement saving, which is critical to retirees, has historically been governed by the Employee Retirement Income Security Act of 1974 (ERISA), ensuring fiduciary oversight. But over the last several decades, retirement offerings have shifted from defined benefit (DB) plans with ERISA oversight to defined contribution (DC) and other account-based plans not under this governance. According to March 2016 Bureau of Labor statistics, 8% of all establishments offer defined benefit plans while 46% offer defined contribution plans. This major shift from DB to DC plans has removed responsibility from the employer to contribute sufficiently to pay a specific amount, based upon years of service and the employee’s salary, for the duration of the retiree’s life. With defined benefit plans all of the risk related to accumulating and protecting savings and ensuring that the savings should last throughout the retiree’s lifetime was the responsibility of the employer, operating as a fiduciary under law. With defined contribution plans, all this identified risk, along with fiduciary risk, has been transferred to the ill-equipped employee.
Recognition of this precarious shift has rightly elevated concerns among all involved. Assuming that consumers recognize their plight, the expectation might be that they would reallocate all of the responsibility once held by employers to financial advisors. But financial advisors are not in a position to ensure that retirees have enough savings; and they can only advise, not protect, against volatility/loss risk and longevity risk (the risk of running out of money).
For employers, shifting responsibility to employees also carries risk. Without guaranteed income during retirement, workers may remain employed longer than desired, creating cost pressures due to higher salaries and other employee benefits such as longer vacation time, higher healthcare costs, and severance costs. Alternatively, retirees unable to support themselves financially put strain on entitlement programs and society at large. With DC plans, risk exposure is large for both employer and employee; but if the employee at least receives guidance from an advisor operating as a fiduciary, the hope is that employee, employer, and society will experience the best possible outcome.
Without ERISA protection to address contemporary risks – including participation risk, investment risk, distribution risk, and longevity risk – there are concerns over advice that stem from conflicting regulations. Differences in the regulatory structure that governs broker-dealers (suitability standard) on the one hand and investment advisors (fiduciary standard) on the other have resulted in different standards of care being exercised by individuals whose qualifications appear similar. Aggressive marketing practices, using terms like financial planner and financial consultant to describe brokers, and advertisements alluding to how a broker’s actions are in the client’s interests, further blur the demarcation. Investors fail to distinguish between broker-dealers and investment advisors as they are defined by federal regulations. Yet these different standards have quality implications. The suitability standard by which broker-dealers operate effectively allows brokers to maximize rent extraction from clients, while the fiduciary standard required of Registered Investment Advisors (RIA) is principles-based, disallowing any leeway in quality. RIAs must be able to prove that their recommendations are in their clients’ best interests.
The new DOL fiduciary rule is designed to assign fiduciary responsibility to all advisors when they advise on retirement money outside of ERISA jurisdiction. Note money not identified as “retirement” is not covered.
There are many issues and concerns regarding the DOL regulation, but two of the most serious are rarely discussed. Firstly, rather than requiring all advisors to operate by a principles-based process where demonstration of fiduciary behavior is required, the DOL regulation has created more rules and boundaries for advisors to navigate and perhaps attempt to circumvent. Ethical behavior can never be effectively regulated by rules, since there will never be enough rules to cover every decisional permutation. To be a real fiduciary one must be prepared to justify the logic of their advice and recommendations in light of all relevant information and circumstances. The Investment Advisor Act of 1940 recognized the impracticality and danger associated with defining fiduciary rules and thus creating the illusion of ethical behavior. Similarly, the new DOL fiduciary rule could give the appearance of instituting optimal rules of conduct where they don’t actually exist.
This concern leads to another. Once conflicts of interest are removed and a fiduciary regulation is in place, the assumption is that financial advisors will be capable of advising in the client’s best interest. But research strongly indicates that financial illiteracy is rampant in the US; and worse, inappropriate confidence and hubris encourage bad financial behavior. Financial advisors who are not formally trained in economics, finance, and financial planning are just as vulnerable to a lack of financial knowledge as the rest of the population is. Financial advisors who were hired for their sales skills and affluent networks are not necessarily qualified to offer fiduciary financial advice.
Cumberland has been a fiduciary firm since 1973 and is committed to providing responsible, merit-based advice. We can operate as fiduciaries because we have personnel who have completed university training and earned bachelor’s, master’s, and PhD degrees in finance and economics. The knowledge gained from university training is fundamental to our ability to operate as fiduciaries. Additionally, decades of experience and further professional certifications have greatly enhanced our ability to operate as fiduciaries. We believe that while compensation methods, disclosure policies, and regulations might keep an advisor from bad behavior, financial knowledge and expert understanding of the myriad of options available to clients are what define a fiduciary. A true fiduciary understands that the more you learn and the more expert you become, the more you realize how much there is to know. Accordingly, you closely monitor a complex and ever-changing investment landscape in order to offer your clients the best possible investment options and advice.
