Christopher HopkinsToday we are confronted with a bewildering array of investment options. This is generally a good thing, as many of those options serve to increase choice and lower costs, high priorities for intelligent investors. But the increase in complexity sometimes brings increased opacity that may obscure hidden fees, charges and expenses buried within the legalese. High fees over time can seriously impede your investment returns, potentially robbing you of thousands of dollars you could use in retirement. Before you buy any financial product or engage an adviser or salesperson, ask questions until you are fully comfortable.
The process is complicated by the different business models employed in the financial services industry. Purveyors of investment vehicles and advice generally fall into one of two camps.
Brokers, agents and other salespeople following the traditional model are compensated via commissions. These commissions can be transactional (for example, on a stock trade) or spread out over time (often seen with mutual funds or insurance products).
Advisers (or advisors, interchangeably) are most often paid a stated percentage based upon the value of assets under their management. This annual asset-based fee usually falls between 0.75 and 1.5 percent per year, and is charged directly to the client. This model is often referred to as "fee only" and firms that employ it are overwhelmingly Registered Investment Advisers (RIA).
To add to the confusion, some practitioners are dually-registered as brokers and advisers and operate in both worlds.
Perhaps a more important distinction involves the degree of care imposed upon the financial professional by regulators. Generally speaking, commission-based practitioners must ensure that products and securities they sell are "suitable" for the specific client in question. That standard is broad, and would prohibit, say, recommending a high tech start-up IPO to a conservative 80 year-old widow, but does not bar promoting high-fee products over lower-cost alternatives.
Advisers as defined in the 1940 Advisers Act are held to a higher standard of care. That standard, called a "fiduciary" duty, requires that the adviser place the interest of the client ahead of his own interest in every instance. This is a critical distinction, for it essentially requires an adviser to employ the lowest-cost solution among comparable alternatives. Utilizing a fee-only structure eliminates the incentive to favor high-cost products, and helps align the interests of the client and the adviser.
Note that some commissioned salespeople adopt a title containing the word "adviser" but are not subject to the fiduciary duty of the Advisers Act. Confused yet?
With the demise of traditional pensions, the Labor Department has sought to impose a fiduciary standard on any financial professional giving "advice" pertaining to retirement accounts like IRAs, and 401(k) plans. The action was intended to address both inappropriate recommendations and excessively high fees by holding everyone to the higher "fiduciary" level of care. Unfortunately, as is so often true, the proposed regulation was overly complex and meddlesome, and has been shelved by the Administration for the time being. So it remains essential for investors to understand what they are paying.
When considering a financial product or engaging someone to assist in managing your assets, be sure to ask: How do you get paid and how much? If the representative is unable or unwilling to answer, move on.
Be sure to thoroughly understand the product or service before signing up. In general, the more complicated, the less appropriate for most average investors.
And understand what level of care this person will provide. Are they legally bound as a fiduciary or merely subject to the "suitability" standard? The distinction could mean thousands over time.
Christopher A. Hopkins, CFA, is vice president and portfolio manager for Barnett & Co. in Chattanooga.