Butchers and Brokers
As Nathan wrote about a couple of months ago, in April 2016, the Department of Labor (DOL) passed regulations in requiring all financial advisors to act as fiduciaries in dealing with client retirement plans. This rule was aimed squarely at the brokerage industry which had been operating under the “suitability” legal standard—which only requires that brokers must deem an investment product suitable for you, it does not have to be the best product or the best option for you. And it didn’t matter if they recommended a product that paid them more in commissions than another product that may be a better fit for you as long as the higher commission product was suitable.
On the other hand, advisors that operate under the fiduciary standard are legally required to put the interests of their clients first at all times. Fiduciaries must avoid conflicts of interest and operate with transparency at all times.
This quick video by Hightower Advisors tries to illustrate the difference by comparing butchers who sell meat to dietitians who give advice about what to eat. Just as you would not expect your butcher to give objective dietary advice, by extension, you shouldn’t expect your broker to give you objective financial advice either. If you want sound and prudent advice about what to eat to be healthy, you go to a dietitian, and therefore when you want financial advice, you go to a fiduciary.
While the video does an admirable job at quickly illustrating the difference between brokers (who are paid to sell products) and fiduciary advisors (who are paid to give objective advice and act in your best interests), advisor Michael Kitces makes a great point that the video actually highlights what is wrong with the DOL ruling.
The DOL rule was a great start at attempting to reform an industry rife with conflicts of interest. However, instead of the rule requiring all advisors to be fiduciaries (i.e. all butchers must be dietitians), the simpler answer would have been to clearly define the role of the brokers as product salespeople (i.e. butcher is a meat salesman). As Kitces points out in his excellent blog post:
“…the problem is not that brokers aren’t fiduciaries, or what standard should apply to the advice that brokers give; the problem is that stockbrokers (and insurance agents, and other financial products salespeople that stopped calling themselves what they are and started calling themselves ‘financial advisors’ and ‘financial consultants’) shouldn’t give financial advice or hold themselves out as financial advisors or consultants in the first place. Which means in the end, the solution is not to make butchers into dieticians or brokers into fiduciaries; it’s simply to draw a clearer distinction between who is a fiduciary advice-giver and who is a product salesperson, by calling a butcher a butcher, a broker a broker, and the only people who hold themselves out as advice-givers – regarding diet or finances – are the advisors.” –Kitces