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The DOL Fiduciary Rule

Bill Watts - June 02, 2016

The U.S. Department of Labor recently announced stronger regulations for financial advisors overseeing retirement accounts. Commonly known as the "Fiduciary Rule", these regulations require financial advisors to act in the best interest of their clients.

Advisors might not act in the best interest of their client because of the way in which they are paid. Financial advisors are normally paid in one of two ways:

  1. Management fees (a.k.a. front or rear loaded payments) - when a transaction occurs in a client's account, the advisor is paid a percentage of the total transaction, like a commission
  2. Fee-based - costs are often structured based on a percentage of the client's total investment account, or on an hourly basis

Management fees have often led advisors to recommend transactions that aren't in the best interest of their clients, in order to earn more revenue for themselves. The White House Council of Economic Advisers estimates that misguided investment advice costs clients $17 billion per year. Under these new regulations, advisors must clearly disclose any fees that are associated with a new investment opportunity and be able to justify not using a lower-fee option.

For Example

For example, on a $100,000 investment, a 5% advisory management fee would cost $5,000. If the investment took eight hours to research, recommend, and prepare, at $200 per hour, the advisory fee would only be $1,600. Even with these DOL regulations, some transaction-related charges will still be incurred. However, these transactions charges are nominal when compared to standard management fees.

The importance of these new regulations can be clearly seen by using the standard formula for the Future Value of a cash flow:
Future Value = CF*(1+r)^t
where CF is the initial investment, r is the compound interest rate, and t is the number of years.
On a $100,000 investment, if the compound interest rate is 4.5%, and the money is invested for 30 years, the future value is $374,531.81. If front-loaded management fees of $5,000 brought the initial investment down to $95,000, then the future value is only $355,805.22.

A retiree has less money if they are losing part of their investment to management fees. Unless the fees are clearly disclosed, a client could easily be taken advantage of and would never know about this lost money. It is vitally important that consumers are able to rely on their advisors, and these new regulations support that. If a consumer has a better understanding of the financial world, then they can be even more protected against abuse.

As a business professional, I am certainly interested in an eventual "end-game" situation where I can retire from my career. This can only happen if I get good financial advice in preparation for retirement. I am excited about the stronger Department of Labor regulations, since they protect me as a consumer and discourage my financial advisor from making recommendations solely to benefit himself. (Fortunately, I work with an excellent financial advisor that I completely trust, so I don't think this is actually a problem for me.)

Further Reading

Additional Thoughts

"The DOL prefers a fee-based relationship, as do many financial advisors, because then there is no conflict of interest when picking the investments. I've always said that this puts us on the same side of the table as our clients. What you'll see going forward however are more fee-based products and investments and also some fee compression. The people who will be impacted the most by this rule are actually the smaller investors and also advisors who are just starting out. These are negatives, in my opinion, of the DOL regulations."
- anonymous financial advisor