Should the companies managing your 401(k) be allowed to sell you products that they know will actually make your retirement less secure? That’s the question being debated in Washington, as regulators mull rules that would require the financial-services industry to act in the best interest of its clients when giving advice on which investments to buy.
This fall, the Department of Labor is expected to issue a new rule that would impose a “fiduciary duty” on investment professionals who service company-sponsored retirement accounts, like 401(k)s, as well as individual retirement accounts (IRAs). But in a somewhat surprising move earlier this summer, 32 liberal Democratic representatives sent a letter to then Acting Secretary of Labor Seth Harris urging him to reconsider the department’s plans, arguing that it “could severely limit access to low-cost investment advice.”
This is a curious statement, since what they are essentially saying is that if the industry were forced to give only sound advice in good faith, it would be less profitable and therefore forced to stop serving investors with smaller accounts.
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It shouldn’t come as a complete shock, then, that on Tuesday, Mother Jones magazine revealed that the letter was actually written by Robert Lewis, a lobbyist for the Financial Services Institute, which is backed by the investment-advisory industry. According to the report, these lawmakers have received more than $80,000 in contributions from the securities-and-investments industry during the past election cycle, fueling speculation that these representatives are more concerned about the financial industry’s profits than they are about protecting the interest of the average investor.
It does seem strange in this time of acute partisan discord that congressional representatives of both parties are in agreement that the Labor Department rule — and a similar but potentially broader rule under consideration by the SEC — is cause for such concern. In recent weeks, both House Republicans and Senate Democrats have made efforts to slow or stop the implementation of the fiduciary rule.
Would lawmakers from both parties be falling over themselves to roll back these regulations if it weren’t for the hundreds of lobbyists and hundreds of thousands of dollars the financial-services industry has been sending to Washington this summer? It’s impossible to know for sure, and, of course, lawmakers’ public statements make it appear as if their concern is for the average investor rather than for the industry. But if the fear is that these rules will “limit access to low-cost investment advice,” then opponents of the rule should be pretty sure that advice the financial-services industry is selling is worth the price we’re forced to pay for it.
The thing is, it’s clearly not. Over the past 30 years, a confluence of forces has changed the American retirement system from one largely reliant on defined-benefit pension plans to a system based on individual retirement accounts that workers are responsible for managing themselves. The results have been disastrous. Workers have a difficult time saving enough money needed for a secure retirement, and when they do, they are taken advantage of by a financial-services industry that steers them into expensive products that do more to pad the industry’s bottom line than to build up retirement savings. The result is a vastly underfunded retirement system, and a generation of soon-to-be-retirees who have no idea how they’ll support themselves once they’re no longer able to work.
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It’s not for a lack of effort on workers’ part, however. According to the Investment Company Institute, Americans have invested roughly $19.5 trillion in retirement assets in 401(k) accounts, IRAs and other retirement-investment vehicles. This massive pile of cash is a big moneymaker for the financial-services industry, generating tens and possibly hundreds of billions of dollars per year in fees.
While these fees are huge in the aggregate, they easily escape the attention of the typical saver. The average mutual fund charges just 1% or 2% in fees, but those charges end up costing you a lot over the long run. As the Department of Labor explains:
Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.
Meanwhile, investors could be parking their money in passively managed index funds like the well-known Vanguard 500 Index Fund, which owns slices of 500 of America’s largest corporations. The fund charges 0.17% in fees, which is exactly why most investment professionals aren’t going to steer you toward such product. Money in index funds doesn’t support an army of portfolio managers, analysts and marketers.
And this is where the fiduciary rule the Labor Department is pushing would come in. Instituting a rule that requires advisers serving employee or individual retirement accounts to act purely in the interest of the client would go a long way in moving some of the billions of dollars the industry makes in fees each year back into the retirement accounts of folks who need them most.
With a retirement-savings gap that’s been estimated to be as much as $14 trillion, and Washington fighting over how much we need to cut Social Security, the American retirement system simply can’t afford to support an investment industry that makes billions from deliberately confusing its clients and steering them toward expensive products that shrink retirement accounts over time. The fact that the industry admits that it would have to drop the business of lower-income folks if forced to act in their best interest should tell you all you need to know about the value of its advice.