By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen
At the risk of self-promotion, allow me to point you in the direction of a piece by me running today in The New Republic. It’s about a proposed update to the Department of Labor’s fiduciary rule, and how the financial services industry, along with members of both parties, are working to stop it. An excerpt:
The Labor Department proposal, known as the “fiduciary rule,” would change the ethical standards by which employer-based retirement products like 401(k)’s and IRAs are marketed and sold. The rule has not been updated since 1975, before 401(k)’s and IRAs even existed. The Labor Department wants to broaden the definition of a “fiduciary” to cover all financial advisers who offer individual investment advice for a fee. Under the rule, they would be legally required to work in the best interest of their clients. For example, a fiduciary would not be able to push investment products on customers in which they have a financial stake…
Currently, it is depressingly common for financial advisers, more than 80 percent of whom are not fiduciaries, to self-deal when offering advice. First off, they obtain large fees from the retirement products they sell. According to the think tank Demos, a median-income, two-earner household will pay $155,000 during their lifetime to financial advisers on average. (The lifetime gains for two-earner households from retirement accounts are around $230,000, meaning that nearly two-thirds of the profits go to the industry.) Second, non-fiduciary financial advisers can enjoy kickbacks; right now there is no rule against an adviser from a mutual fund company encouraging clients to put their money in specific funds sold by that company. In fact, that’s the norm, and the adviser typically receives a commission for the sale.
Conflicts of interest like this cost retirement investors at least $1 billion a month, because the funds they get channeled into underperform the alternatives. Financial advisers also encourage rollovers into high-cost IRAs when an individual changes jobs. None of these schemes have to be disclosed to the customer, under the current standard. The National Bureau for Economic Research found in a recent study that “adviser self‐interest plays an important role in generating advice that is not in the best interest of the clients.”
As they say, read the whole thing. This is all a function of throwing our retirement security into the hands of financial industry personnel who can’t help but use it as a rent-extraction opportunity. The solution isn’t to try to regulate that process per se, but to expand Social Security and return to defined-benefit pensions rather than to spend hundreds of billions every year in tax preferences for retirement accounts, effectively having the federal government act as an accessory to the thievery. But the absolute least we can do is create standards so that the advice millions of Americans get on their retirement money does not come from anyone looking to rob them.
This, like so many things when it comes to Wall Street, is a bipartisan problem. The House Financial Services Committee vote on H.R. 2374, the Retail Investor Protection Act (it does the opposite, delaying the Labor Department’s proposed rule and actually making it impossible to enact) was 44-13, with broad support from Republicans and Democrats. The bill could hit the floor this week, even with the shutdown.
The two major arguments by the industry, in an effort to protect their predatory fees and prevent being mandated to act in their clients’ best interest, are completely contradictory. First, they say they merely offer advice to low-level investors as charity, and the institutional investor accounts subsidize this service for small investors. At the same time, they argue that if the fiduciary rule goes through, they’d have to cut off all their products for small investors because they wouldn’t be able to afford the services. This makes no sense at all. If advice to small investors is unprofitable, why would they have to abandon it based on affordability? Multiple Hill staffers pointed out this contradiction to me for the piece.
This didn’t make it in the article, but it turns out that the intellectual foundation for the industry’s claims comes from a study by the financial consulting firm Oliver Wyman. The study, which claimed to use data from 12 different financial services firms, concluded that the industry would have to modify its offerings if faced with the new fiduciary rule, and that investors would have to pay higher direct costs for financial advice.
The less-told story here is that nearly two years ago, the Labor Department asked Oliver Wyman for the underlying dataset used to form their assertions. And Wyman’s lawyers, Davis and Harman LLP, refused the request from a federal agency. They cited confidentiality agreements with the financial services firms. It took a second request for Wyman to give up the aggregate data, while continuing to withhold the selection criteria for the data. Without that selection criteria, the study is open to claims of cherry-picking in the data.
Given all the tricks and self-dealing from this industry, an allegedly “independent” study that refuses to release the context for its claims is mostly worthless. Moreover, even if you were to take the Wyman study on its own terms, it claims that non-fiduciary advice is valuable, so valuable that brokers could not offer it to small investors if the costs became too burdensome. This directly contradicts the secondary argument, that the industry makes more than enough money off large investors, almost all of whom have a fiduciary arrangement, so they can float cheap advice to the smaller retirement account holders. It’s pretzel logic.
This is a huge deal. The retirement crisis will become one of the bigger stories of the next decade as the baby boomers turn 65. Millions of people are being systematically ripped off and sold a bill of goods about how they can maintain their standard of living after they stop working. And politicians in both parties want to keep allowing the financial industry to perform this deceitful game. While the true solution, as said before, is a total revolution in thinking about retirement, protecting ordinary investors and ending the rent-extraction from worthless intermediaries is at least a start. This one is worth a call to your Congresscritter.
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I am mystified why anyone ever consults any financial adviser. None of them has any idea what he is doing. Jack Bogle made it crystal clear over thirty years ago that any small investor should own an index fund if he owns any stock at all. These impose no fees whatsoever.
In today’s stock market, performance remains hostage to the next financial calamity all but guaranteed by derivative gambling, not to mention nonstop market manipulation by high frequency trading, fictitious accounting which makes sensible stock selection techniques impossible, executive looting which eliminates the lion’s share of potential investor gains.
It is possible and indeed likely that the next generation of retirees will have no gains whatsoever to be sucked out by the so called financial services industry.
“Jack Bogle made it crystal clear over thirty years ago that any small investor should own an index fund if he owns any stock at all. These impose no fees whatsoever.”
Not true. Index funds are not free, but, are some of the very cheapest investment vehicles. The Vanguard 500 index fund only charges .05%.
I do agree that advisors are useless. One can easily educate themselves from various free sources on the internet, and read Bogle, as you mentioned. Even Buffet has said more than once that a simple stock/bond allocation in index funds is the way to go for individuals, and the numbers over the last 40 years prove that.
There are two basic principles of investment advisors.
#1. If the investment advisor does better than an index fund… he will charge accordingly, and YOU will not do better than an index fund.
#2. If you don’t know how to pick stocks on your own, you also don’t know how to pick an investment advisor.
This makes investment advisors useless under almost all circumstances, though they can be useful under certain highly specialized circumstances involving very busy rich people hiring their less-busy close friends.
Ccontact my congresscritter??? He’s getting campaign contributions from these crooks. Why would he want to fix it???
He/She/It won’t want to fix it. But if He/She/It is contacted by enough people, the Congress Critter might reluctantly vote to fix the fiduciary rule.
Congressional Contact Information
The total population in my district congressional district is about 500,000. If roughly half of those are of voting age that would leave about 225,000 who might vote. However, only about %70 of those folks are actually registered to vote which leaves about 175,000. About %30 of the registered voters turn out to vote in a non-presidential election year. We are way below a critical level now at about 52,000 folks; for a Congress person to listen, anything less than half of the voters can pass on an issue and the rep is off free. In addition out of the registered voters in my district, how many will know about this issue? %1 at most; Congress gets a free pass on this.
Congress gets a free pass on almost everything. But if some members notice a small spike in constituent messages about an arcane topic such as H.R.2374, they might decide that discretion is the better part of valor.
But you’re probably right — why waste 2 minutes on a phone call to your representative, when you can spend 5 minutes writing a message on NC about how pointless it is to contact Congress?
Congress ran away from another “smart war” in Syria, and only 11 GOP votes were needed to put a serious hold on the NSA.
Shame can work; although, phone calls work better than internet petitions. Congress is full of people who aren’t the most with it people on the planet and don’t fully grasp the implications of the internet. Yes, they can say, “facebook it,” but they don’t grasp the movement of lives in a practical matter. Phone calls and letter still scare them especially if you ask about their donors. If you write to Mark Warner, you might be lucky to get a response, but if you put “JP Morgan” in the subject line, they send a response almost immediately.
Timely article for me. My parents are boomers a few years away from retirement, and one of them was pointed in the direction of a “financial advisor” who provided a “free consultation”. This advisor used very heavy-handed scare tactics in an attempt to get my parents to commit 100% of their IRAs to this ludicrous “hybrid annuity” type product while never disclosing that he would receive a large commission if they did.
After looking through the marketing pamphlets for the annuity (heavy on buzz words, low on content) I was able to deduce from the fine print that this investment vehicle was almost comically terrible with heavy management fees and penalties for early withdrawals and stringent caps on how the gains would be paid out. After speaking with the salesman on the phone it was obvious he was both incompetent and unethical.
Now I’m spending my free time looking around online trying to figure out an appropriate approach to partition their retirement savings, but many of the online resources have their own agendas. I feel bad for the millions of boomers who aren’t inclined or feel powerless to research on their own because they’re going to be paying massive commissions on their lifetime savings to a predatory industry that has no accountability to their customers.
Rusti,
Not going to give you a website to point you to, but will provide a few thoughts (both as a late-late Boomer and early X’er, and as individual who had to face a similar issue for an elderly parent)
First: don’t start with “where to put the savings” question. Start with expenses. Look at what and how they spend today. And most importantly, look at what they’re afraid of.
Second: don’t believe the hype about “you’ll need 80% of your income in retirement.
Third (and this is a general rule of thumb for any financial product): If someone has to explain it to you and it takes more than 30 seconds, run like your hair is on fire.
Action steps (for you or for them):
1) Put together a personal balance sheet (or just a simple list of what they own and what they owe). Any assets they plan to get rid of?
2) Put together a P&L statement — what is their income and what do they spend on a monthly basis (and annual basis).
3) Look at how 1 and 2 may change in retirement. Not commuting to work? Not saving for retirement? More meals at home? More meals out?
4) Look at what they want to do when retired (which will impact 3).
5) Put together a post retirement P&L.
6) Determine the shortfall on the P&L (maybe there isn’t any). I’d also risk rate the sources of income in post-retirement — if a substantial portion is coming from a municipal or corporate DB plan, you may want to think about what would happen if it was reduced by 50% or more.
ONLY after you’ve gone through this exercise should you start thinking about “where to put the money”.
Annuities (theoretically) solve one problem: running out of money in old age — which I think is the #1 TERROR of most retirees and seniors. But it comes at a HIGH price.
Hope this helps.
PS — I’ve included a link below to Vanguard’s Funds Performance Page. Low fee and a good mix — look at the 10 year averages.
https://personal.vanguard.com/us/FundsByName
Ed,
Thanks for the advice, this is a really sensible approach for us to follow. I think like many people my folks are having difficulty with 4&5 (Retirement lifestyle and expenses) because it’s something of an iterative process seeing what sort of lifestyle accrued savings and future investment gains can realistically provide.
Rusti,
A clarification on my link to Vanguard: it’s not an endorsement of Vanguard or any of their products. But they do have a good mix of funds (and low fees) — use it as an educational tool to evaluate the claims of any other financial product (e.g. “you haven’t done any better than Vanguard’s SP500 in the last 10 years AND you charge 1.5% to invest?)
Having done this myself for about thirty years, let me offer a suggestion. Have them take 20-30% of the money and select a portfolio of six large cap stocks none of which is likely to crater in the foreseeable future. Commit 1/6 of the money to each stock, but don’t make the full commitment all at once. Divide it in 4-5 pieces, and make a buy with one piece every 4-6 months until fully committed. Never sell any of the stocks and don’t worry about how much you pay for them. They will eventually be “in the market” as much as they should be. They will not get the bottom, but they will not get the top, either. Put the rest of the money in something absolutely safe. I use Treasury bills, even though they don’t pay anything. (It is very nice to never pay taxes.) Now comes the important part. Reduce your living expenses to fit your assets. They probably aren’t making any income, right? Instead of wasting time on the golf course, they should consider getting a job in one of those retirement communities. The guys hustling golf carts have essentially the same life style as the ones digging up the course, and they get paid for it.
“The guys hustling golf carts have essentially the same life style as the ones digging up the course, and they get paid for it.”
A bit cynical for those that like to play. Maybe the hustling will earn them free golf…
Nobody likes to play more than I do. But at age 70 golf is just work, and in 58 years I haven’t found a way to make it pay.
What sorts of stocks do you consider crater-safe? Utilities?
I agree with your philosophy about turning money-wasters into money-neutral activities, though social security will fortunately cover a big chunk of their expenses because they’ll have a relatively high payout and low cost of living.
Jack Bogle made crystal clear that you need some equity exposure. But purblind gov-lovers who missed out on Markowitz et al are still telling us that ‘the solution is … to expand Social Security’ — which holds nothing but low-return, unmarketable Treasuries.
Great recipe for keeping the middle class poor. Struggle, comrades!
Respectfully, in recent years the basic assumptions of MPT have been widely challenged. From wikipedia:
“These include evidence that financial returns do not follow a Gaussian distribution or indeed any symmetric distribution, and that correlations between asset classes are not fixed but can vary depending on external events (especially in crises). Further, there remains evidence that investors are not rational and markets may not be efficient.[4][5] Finally, the low volatility anomaly conflicts with CAPM’s trade-off assumption of higher risk for higher return… A study conducted by Myron Scholes, Michael Jenson, and Fischer Black in 1972 suggests that the relationship between return and beta might be flat or even negatively correlated.”
Wall Street has been seeking to offload stocks into the Social Security and Medicare trust funds for a long time. IMO this would be a very poor policy decision in terms of the public interest.
Great article. Thanks. The retirement crisis is an untold story and must be exposed.
I concur: great article.
I don’t think you can hit this issue enough. I’m particularly concerned about all those folks who are living under the illusion that because they have $100,000 or even $250,000 in their IRA, withdrawals are going to provide them adequate retirement income.
Do the math!!! And particularly, do the math when deducting for the taxes that have to be paid. Is $3000 – $7000 per year from an IRA, when added to social security [if you have it] and a non-existent “pension” going to be enough to support a boomer or boomer couple?
Folks need to be reminded of these cold, hard facts, and often!
Anyone can do the math, and the financial advisers do it for those who cannot. The entire industry feeds on fear and fantasy. Superior performance is an illusion not much different from the ‘satisfaction’ trumpeted by the cigarette industry.
I suspect ‘retirement’ is a thing of the past for 90% of the population. Instead of retirement they can look forward to a minimum wage job. Walmart is expecting them with open arms.
Whats so different than drunken dutch men trading IOUs, now that everyone has to do it, in some form or another.
skippy… some say the bars are invisible, methinks not.
Bravo David – an old story but one that gives us a good indication what “financial services” really are – theft.
Retirement is essentially paid for by future work. We can’t really pay for it now. It should be a matter of agreed obligation. Pensions only worked because a small number got to draw them as survivors on a tontine.
We need to get round to an understanding that nearly all financial services are theft and could be replaced by honest machine banking.
One simple question to ask about an advisor is what is in it for them? If they get different commissions depending on what they push they have a conflict of interest. Actually short of a financial advisor who is fee only and does not get any kickbacks depending on what the recommend, all others have conflicts of interest to some degree. Only registered investment advisors have the requirement now. So just say thanks but no thanks on advice from anyone else, assume they are in it to get rich for themeselves. I agree with the notion that if you can’t understand it in 30 seconds just say no. (The recent financial crisis demonstrated that a lot of “sophisticated investors” are to chicken to say no, and their advisors have a conflict also).
But going with index funds does mean giving up the idea that you can make a killing on wall street, and admiting that you won’t beat the market, but with low cost funds will come close to being even with it.
Just being in the market made anyone a killing between 1920 and 2013. History tends to repeat itself, because debt cannot be serviced without some kind of price inflation, and the kind easiest to engineer is asset inflation. The trick is to avoid getting shaken out in the reversals, even when the newspapers scream about a crash.
While I don’t disagree with much of this analysis, I think the Demos report overstates the expenses that most people, and certainly those who work for large employers, pay in their 401(k) plans, I read through the Demos report and really think the only thing you can conclude is that the Demos 401(k) plan is very expensive and they really should switch providers. 70 bps for the State Street S&P 500 index fund? Also, his explanation isn’t very clear, but I think he may be double-counting trading costs, and maybe fees as well, by subtracting them from returns when mutual fund returns are reported net-of-fees.