Registered Investment Advisors like Pinnacle Advisory Group are held by law to a fiduciary standard. That means that we’re bound to act at all times in our clients’ best interests, even if those interests should clash with our own. In doing so, we have a legal obligation to disclose to our clients exactly how we’re to be compensated, as well as any related conflicts of interest. At Pinnacle we have met this standard since we started the company in 1993.
Surprisingly enough, stock brokers are not held to the same standard. While consumers surely expect objective advice from their financial advisors, the large wire houses and their brokers are not actually required to provide it. I don’t usually dwell on industry squabbles since I assume that the players with the most clout in Washington – namely, the large broker-dealers who do not want anything to do with the legal restrictions and liabilities of having to meet a fiduciary standard – will ultimately win out. However, a report just crossed my desk that I think will be of interest to you.
The document I’m referring to is the April 2012 Quantitative Analysis of Investor Behavior, Advisor Edition, prepared by DALBAR, Inc. – a financial services market research firm. In a section entitled, “Do Fiduciaries Produce Better Returns?” the researchers highlight four separate issues related to fiduciary standards.
First, they point out that the registered investment advisor industry, and others promoting the idea that consumers should be protected by requiring that broker-dealers meet a fiduciary standard, draw a distinction between urging an investor to buy or sell (non-fiduciary) and making a recommendation that an investor buy or sell (fiduciary.) They point out that since it’s practically impossible to enforce the difference between selling to an investor and recommending a security, all selling should be considered a fiduciary act. I couldn’t agree more. Of course, since Pinnacle has the discretionary authority to trade our client’s accounts for them, we have always had to meet this standard anyway.
Their second point is that having a fiduciary standard would increase pressure to lower expenses, which would consequently make the investment business less attractive to professionals. According to DALBAR, this would result in fewer advisors, which would lead to higher prices. As far as I can tell, they are suggesting that lower costs for consumers is a bad thing, and recommend (I know, this is amazing) that fiduciaries “revise their compensation practices so that a premium is paid for a fiduciary relationship.” Pinnacle has no intention of raising our prices any time soon, but it’s gratifying to know that we’re worth a premium in the investment advice marketplace.
The third point raised in DALBAR’s commentary is valid. Their researchers state that the compensation structure used by most fiduciaries — charging fees for assets under management — leads to high minimum asset balances to compensate advisors for lower compensation practices. This, of course, results in clients with lower investment balances remaining un-served by fiduciaries. Fair enough. Pinnacle’s $750,000 minimum client size means that we can only apply our skills to the affluent market. This leaves smaller clients to deal with non-fiduciaries selling investment products through wire houses. As a solution, the authors of the report propose a rational pricing system that actually sounds similar to Pinnacle’s pricing structure. (Nevertheless, if I had a smaller portfolio, I would still want to know if the person selling me financial products did not have to meet a fiduciary standard.)
The fourth consideration in the commentary is that advisors who are bound to a fiduciary standard are less likely to propose higher risk assets because of fear of fiduciary liability. Therefore, clients will ultimately earn lower returns due to the risk aversion of their advisors. In practice, RIAs who make objective investment recommendations based on the facts and circumstances of their clients’ financial plans are perfectly comfortable recommending that their clients take investment risk. In fact, the liability could come from not recommending a risk asset where appropriate for a particular investor. Even advisors who determine client suitability by using a questionnaire end up recommending growth-oriented portfolios for those who are suitable. In fact, DALBAR recommends that advisors could “use a process in which the investor can make an informed decision, with full knowledge of the reasonable level of return and potential loss that can be expected.” I’m sure this process sounds familiar to every Pinnacle client — and to clients of financial planners across the country.
We sometimes take the benefits we provide our clients for granted, and being a fiduciary is one of them. The fact is, our clients don’t have to worry about a conflict of interest between our goals and theirs when it comes to helping them achieve their financial ends. Our recommendations as both financial planners and investment advisors meet a fiduciary standard, and our compensation structure is clear and transparent. Our clients put their complete trust in us, and we are bound by law to live up to it.
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