There’s been a lot of talk about this new rule that has been passed and finalized by the Department of Labor that was effective April 6, 2016. The Department issued a rule that would require advisors to abide by a fiduciary standard whenever they are advising a client about any kind of investments that would originate out of their IRA, anything they are rolling over into an IRA, their 401(k) or any asset that they have that is subject to federal ARISA regulation. It’s a huge change for the financial world.
The Department of Labor says, if you are a fiduciary, the only way you can provide advice without a conflict of interest, is if you get paid a fee for managing assets over time. There are two ways that people get paid. Some types of financial products pay an upfront fee. But all of the sudden in financial services there is this association that if you advise somebody to take a product that pays a commission you are providing a conflicted opinion to them. You are giving them advice that’s conflicted. Because I have clients that need a product that they will pay into, they will buy the product one time and that product pays a one-time fee to the advisor, to our firm for putting that client in that product.
We put them into a product that they need, and they have the choice of several products that they can pick the one that makes the best sense for them. Instead of just offering them one option, they also have the option of putting their money in as managed money that we can manage for them for the rest of their life, and that’s called assets under management (AUM).
We have two options here, we can put money under management and they will pay one percent of that money for as long as they have that money under management. And now, obviously, there is an incentive for that advisor to grow that person’s money because they are getting paid one percent every year on average, and the more money that person has, the higher that fee is and they have an incentive to keep the client happy and want the account to grow. AUM is now seen as the non-conflicted way to give advice.
If I am managing your assets, and I am charging you one percent, and I don’t think there’s anything wrong with that; I have no problem with that model. When you start saying that that model is better and superior to and non-conflicted in opposition to the model that pays a one-time fee and never pays again, you’re wrong. And you are wrong because that client will pay more over the life of that investment on the assets under management model than they will ever pay by getting put into a product and having that product pay a fee one time to the advisor and being done.
If the one time fee that might be six percent on average, and that money is in a product that makes sense for that client, and they get one fee one time and it’s done, and that client never pays a fee again on that money or is it that same client who puts that same money into an assets under management model, they are going to pay one percent forever as long as that money is managed. I can tell you that’s more than six years. If a client has assets under management, they’re paying assets under management fees for more than six years usually.
So, why is it better that they have to pay every year, why is that inherently better than a payment that comes from the company to the advisor for the right product to put the client into? If the government told you that you couldn’t pay your realtor a one time lump sum fee but instead had to pay them a flat percentage every year you owned the house, would that be better for you? Some of these ideas are just silly…
Learn even more about the Department of Labor Rule in this segment of Smart Money Mondays.
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