Who Will Guard Your Nest Egg?

 ”Make no mistake about it, you are engaged in a brutal zero-sum contest with the financial industry — every penny of commissions, fees, and transactional cost they extract is irretrievably lost to you.” – William Bernstein.

Previous posts have discussed the advantages of using a fee-only financial planner and also the possible conflicts of interest that may arise when working with a commission compensated planner.

Certainly, Wall Street investment firms spend a lot of money on advertising, making it seem as though their interests are aligned with yours. So, it is understandable that the majority of consumers are unaware of the difference between a fee-only planner and someone who calls himself/herself a financial planner but who is actually a salesperson.

In Saturday’s Wall Street Journal, Jason Zweig delineates the nature and extent of the confusion.

Brokers must recommend only investments that are “suitable” for clients.

(Registered Investment) Advisers act out of “fiduciary duty,” or the obligation to put their clients’ interests first.

Most investors don’t understand this key distinction. A report by Rand Corp. last year found that 63% of investors think brokers are legally required to act in the best interest of the client; 70% believe that brokers must disclose any conflicts of interest. Advisers always have those duties, but brokers often don’t. The confusion is understandable, because a lot of stock brokers these days call themselves financial planners.

Brokers can sell you any investment they have “reasonable grounds for believing” is suitable for you. Only since 1990 have they been required to base that suitability judgment on your risk tolerance, investing objectives, tax status and financial position.

A key factor still is missing from FINRA’s (Financial Industry Regulatory Authority) suitability requirements: cost. Let’s say you tell your broker that you want to simplify your stock portfolio into an index fund. He then tells you that his firm manages an S&P-500 Index fund that is “suitable’ for you. He is under no obligation to tell you that the annual expenses that his firm charges on the fund are 10 times higher than an essentially identical fund from Vanguard. An adviser acting under fiduciary duty would have to disclose the conflict of interest and tell you that cheaper alternatives are available.

If brokers had to take cost and conflicts of interest into account in order to honor a fiduciary duty to their clients, their firms might hesitate before producing the kind of garbage that has blighted the portfolios of investors over the years. (Emphasis added.)

Conclusion

Panicking and pulling out of the stock market following a steep decline, concentrating your investments within a narrow range of options, and too much trading and too little long term holding are some of the more common mistakes investors make. Any and all of which will likely result in a reduction of your investment returns.

Understand, though, that high costs can absolutely kill your investment returns, whether from the high fees of a variable annuity or 403(b) plan, high (and often hidden) expenses and fees of some mutual funds, or the opaque mark-up on bonds sold to unsuspecting investors. Your best protection is to ask your financial advisor to sign a Fiduciary Oath. To find a fee-only planner near you, view the NAPFA (National Association of Personal Financial Advisors) web site.

It is encouraging that the issue of who is working in your best interests has been brought front and center by Jason Zweig, a respected author and columnist. Now, let’s see if the Securities and Exchange Commission Chairwoman, Mary Schapiro, proposes changes in legislation that will benefit consumers. The stakes are extremely high, as Wall Street firms make billions from unsuspecting customers.

Entrenched interests never give up power or lucrative business practices easily.