(Bloomberg) -- Investment advisors should act in their customers' best interests, President Obama says. Here's how they don't, and how it can hurt investors.
Right now, only some advisors are fiduciaries, required to put their clients needs first, while many brokers and advisors only need to recommend suitable financial products. On Monday, the White House said it would support a plan to change that.
Wall Street industry groups warn that new rules could raise costs and thus make advice unaffordable to many middle-income Americans. Its not clear what the final administration proposal will look like Labor Secretary Thomas Perez says it will be very different from previous proposals. But the goal is to end biased advice that the administration estimates costs investors $17 billion a year.
Here are five ways that, under current law, advisors can put their clients at a disadvantage:
For many workers with a 401(k) who are approaching retirement, the best option is to do nothing. Their employers offer 401(k) plans with low fees and great investment choices. Theres no reason to move the money to an IRA. But, as Bloombergs John Hechinger reported last year, investment firms push workers to do just that. For example, federal employees are urged to shift assets into IRAs with fees that are 20 times as high as those in the Federal Thrift Savings Plan.
- Read more: Kitces: When NOT to Convert a Roth
When customers buy a mutual fund from a broker, theyre still often charged a front-load fee a one-time fee that can swallow up more than 5% of their money before its invested. The proceeds from load fees help compensate advisors for their time, though there are often far more efficient ways to get advice. More and more investors are asking for no-load mutual funds, but the Investment Company Institute estimates that $630 billion in load funds were sold in 2013, the latest data available. That was up 19% from 2012 and the most since 2008.
While investors might notice a 5% load fee, many other commissions charged by advisors are hard to spot. For example, a 12b-1 fee can be tacked on to a funds expenses every year, with the proceeds often going to an advisor years after he or she sold the fund. Most of these charges should be disclosed somewhere, but it can be very difficult for clients to add up all the various ways an advisor is making money off them.
ACTIVE FUND BIAS
In many investment categories, low-fee index funds have historically performed better than actively managed mutual funds. But when an advisor meets a client with lots of assets in index funds, he or she often urges the client to reallocate into higher-fee funds. When mystery shoppers visited advisors for a 2012 study, 85% were told to ditch their diversified, low-fee portfolios.
Commissions, including load fees and 12b-1 fees, give advisors an incentive to recommend certain investment products over others. Firms can also give advisors bonuses for steering client money into the firms own funds. The result of this biased advice is that investment performance suffers, academic studies show and not just because fees eat into returns. A 2014 study compared self-directed investors with clients who received advice with conflicts of interest. The self-directed investors performed an average of 1.25 percentage points better annually. A 2009 study found that direct-sold funds beat broker- sold funds by 0.14 to 0.9 percentage point per year, even disregarding the broker funds' higher fees. Over time, that performance gap can cost you thousands, or tens of thousands, of dollars.
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