For decades, millions of investors have fundamentally understood the nature of their relationship with their financial advisor. While most people expect brokers and other investment professionals to act in their clients’ best interest and to make prudent decisions while avoiding conflicts of interest and self-dealing, only a limited number of financial advisors are actually bound by the guidelines that define the fiduciary standard.
For years, The Motley Fool has informed investors about the need for a uniform fiduciary standard and the dangers of conflicts of interest between brokers and clients. Delays have thus far prevented implementation of a broad-reaching fiduciary standard, but a recent study makes it clear just how much those delays are costing investors.
The cost of waiting: $1 billion a month
Last week, an article in Fiduciary News examined some recent academic research that sought to answer the SEC’s call to quantify the costs of not having a fiduciary standard. The most recent paper, which came from researchers at the University of Texas at Austin and Indiana University, concluded that 401(k) plan trustees that have conflicts of interest were more likely to hang on to bad-performing fund options than were trustees without such conflicts.
That’s not all that surprising when you consider how the 401(k) industry works. Fund companies and other money managers often act as trustees of 401(k) plans, and they clearly have huge incentives to keep offering their own funds rather than those of competitors, even when alternatives perform better. Moreover, with employees locked into those 401(k) investment options, they have little choice but to accept the underperforming fund choices those trustees pick.
But what is surprising is the extent of the underperformance. The researchers found that the lowest 10% of funds underperformed by 3.6 percentage points annually, compared with investments with similar risk profiles. Fiduciary News then did the math and concluded that with more than $10 trillion in retirement assets, the cost of that underperformance is $12.3 billion per year — more than $1 billion each month.
A collective yawn from Wall Street
Meanwhile, broker compensation continues to center on the same incentives to gather assets and drive revenue. As Fool contributor Molly McCluskey examined late last year, Morgan Stanley (NYSE:MS) recently implemented changes that would reduce the bonuses that their investment pros receive and give them incentives to take bonuses in restricted stock subject to future vesting rather than cash. More generally, brokerage firms have been more eager to define compensation arrangements since Bank of America Corp (NYSE:BAC) got sued by former Merrill Lynch brokers over allegations that the brokers missed out on deferred compensation and retention bonuses that they argue they were entitled to receive.