What is the DOL Fiduciary Rule, and Why Should You Care?

Fiduciary [fi-doo-shee-er-ee]: A person to whom property or power is entrusted for the benefit of another.

Much has been written recently about the Department of Labor (DOL) and its long-awaited fiduciary rule, formally known as “Definition of the Term ‘Fiduciary’; Conflict of Interest Rule—Retirement Investment Advice.”

Released in April 2016, this 1,023 page whopper of a publication provides more rigorous standards for the investment industry regarding how retirement account advice can be dispensed to clients. And enough jargon, clauses, and exemptions to make even the most dedicated personal finance diehard go catatonic.

Thankfully, you don’t need to read it. All you need to do instead is follow some basic rules of the financial road, and this rule becomes irrelevant to your financial future. But more on that later.

Since we’re on the topic, though, let’s review the current advisor landscape and the highlights of the fiduciary rule.

Today, financial advisers are held to different standards, depending on the business model they operate within and the associated regulatory body responsible for overseeing that business model.

One advisory model is that of the Registered Investment Advisor (RIA). RIAs are already held to a fiduciary standard by the Securities and Exchange Commission (SEC).

Another advisory model is the broker model. That business model is subject to the “suitability standard.” It requires that a broker make suitable recommendations based on a client’s personal situation. However, the broker is not required to act in the client’s best interest. The suitability standard is enforced through a the Financial Industry Regulatory Authority (FINRA), a self-regulating industry body.

To boil it down:

  • RIAs are required to act in the client’s best interest.
  • Brokers are required to offer “suitable” investments, but they don’t have to be in the client’s best interest.
  • Unfortunately, investments like variable annuities with high commissions and stiff surrender charges often fall into the “suitable” category. So do index funds with expense ratios of one percent or more.

Recent studies show that most Americans can’t tell the difference, and believe all financial advisors are required to act in their best interest. This is not the case. As a result, the DOL fiduciary rule will be helpful to those who hire advisors to manage their investments. Let’s review some of its major components.

The Fiduciary Rule

At its essence, the fiduciary rule requires financial advisors to act in the best interest of their clients when it comes to retirement accounts (for example, IRAs and 401(k)s) and also requires that advisors formally document why the advice they have provided is in the client’s best interest. If the advisor does not act in the client’s best interest or document that they have done so, s/he will be exposed to potential client legal action.

A whole new world?  Not exactly.

Does this mean that advisors always have to act in a client’s best interest? Or can no longer be paid via commission-based business models? No.

First of all, the rule applies to retirement accounts only. An advisor is not subject to the same standard when advising on a taxable account, even if that account has been earmarked by the investor for use in retirement.

When it comes to fees, the rule creates exemptions that give fiduciary advisors the ability to maintain their existing fee structures if they can demonstrate the advice they are giving is in their clients’ best interest. In particular, the “Best Interest Contract Exemption” allows advisors to continue to using old-school fee arrangements that might otherwise be prohibited under the rule.

In order to do this, they need to commit in writing to putting their clients’ interests first and disclose any conflicts of interest that could affect their judgment as a fiduciary. As a result, commissions, revenue sharing and 12b-1 fees are all still permitted, whether paid by the client or a third party. Some would suggest this is a fairly gaping loophole. Others would say that allowing these kinds of compensation models is necessary in order to give investment firms some flexibility in structuring their business models to provide quality advice to a range of clients, including those with small balances.

Must Read: How Half a Percent in Fees Can Ruin Your Retirement

And even though the rule was issued in April 2016, the DOL is utilizing a “phased” implementation approach for certain exemptions so that firms will have more time to become compliant. As a result, the rule will not begin to take effect until April 2017, and will not go into full effect until January 1, 2018, nearly two years after issuance.

So, to summarize:

  • Retirement plan advisors must act in their clients’ best interest beginning in April 2017; but
  • The new standard applies to retirement plans only (401(k)s, IRAs, and other retirement plans; not taxable account or other investments that are not within retirement plans);
  • Exemptions will enable advisors continue charging commissions and receiving 12b-1 and other revenue sharing money from mutual fund companies; and
  • The rule will not take full effect until January, 2018.

A step in the right direction? Yes. Sweeping change? No.

It will be very interesting to see how investment firms respond to the ruling and how clients respond in turn.

Why none of this should matter to your financial future

As stated previously, you thankfully don’t need to read the 1,023 page DOL regulation. None of this should matter to you, and here’s why:

  1. You don’t need a financial advisor

Managing one’s finances is not rocket science. You may believe it is, thanks to an army of financial services marketing dollars that are continually sent into battle to convince you otherwise. But I have come to believe that anyone (and especially readers of personal finance blogs) can do it themselves by following these steps:

  1. Picking an asset allocation based one’s ability to tolerate and absorb risk;
  2. Selecting a small number of low-cost index funds to create a well-diversified portfolio; and
  3. Periodically rebalancing that portfolio back to the target allocation percentages.

This approach may require some professional assistance at the beginning to get the ball rolling (although Dough Roller, the Bogleheads, and countless other online sources provide more than enough free information), but once implemented there is very little for a financial advisor to actually do on a daily, weekly, or monthly basis to justify investment fees, regardless of whether s/he is a fiduciary or not.

  1. If you don’t want to do it yourself, you can call Vanguard

But I also realize DIY investing is not for everyone. Some people just aren’t interested, and others don’t have time. If that’s the case, that doesn’t mean you need to delve into the netherworld of DOL regulations to understand what kind of advisor to hire. Just call Vanguard. Its Personal Advisor Service will manage your portfolio for a very competitive fee of 0.30% per year. And best of all, they will act as a fiduciary, in your best interests.

The DOL fiduciary rule is a step in the right direction for the investment industry. As a result of this ruling, many expect the industry to move more forcefully in the direction of transparency and fee-for-service advice, and that is a good thing. But in the meantime, remember, there’s only one way to 1) avoid investing any time understanding the fiduciary rule, and 2) guarantee that your investments will be managed in your own best interests, and that is by doing it yourself.

You are your own best fiduciary.

Topics: Retirement Planning

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