If you doubt the public need to be protected from their
local mob bosses banks, their latest hissy fit is an admission that they can’t make what they deem to be enough profits unless they take advantage of their customers.
This object lesson is IRAs. Bloomberg reports that if brokerage firms who manage IRAs were required to act as a fiduciary, as in put their customers’ interests first, many would exit the business.
The dirty secret of the retail asset management business at brokerage firms is that their profits depend on treating you badly. Unless you are a big enough customer that they would not like to lose you, you are going to be abused (well, take it back, even being a billionaire is not rich enough to be safe from bank predation). The one check on this, ironically, is that salesmen are de facto small businessmen in a bigger corporate umbrella, and their clients are their book of business. They thus have incentives to make sure the customer thinks he is being treated well (whether he is actually treated well is another matter).
The big firms have generally if not completely inferior in-house fund management products they push (inferior by virtue of higher fees and/or not so hot performance). Your “investment advisor” also has an incentive to encourage you to trade if you are in a commission-paying account. The alternative, a wrap fee account, has annual charges that make a serious dent in your principal over time.
Now there may indeed be some imprecision in where the Labor Department draws the line between a fiduciary and someone who is merely peddling products. But the examples the industry defenders cite as practices they want to continue are troubling:
If firms are considered fiduciaries by the Labor Department, selling investors bonds from a brokerage’s inventory or recommending a trade that would generate a commission may be considered a conflict of interest and a “prohibited transaction,” said [Jim] McCarthy [of Morgan Stanley].
The bond example I find particularly troubling. Yes, bonds are over the counter products, so they are always going to come from some firm’s inventory, either the firm that the client is already doing business with or a third party. But unless the account in question is pretty large, it has no business buying bonds The transaction sizes for most individuals are the equivalent of odd lots, and the buyer is almost assured to get a worse price than an institutional investor. The overwhelming majority of individuals are better off putting their money in bond funds.
The article made it clear the industry was trying to say that small fry (those with under $25,000 in an account) would be hurt, when those are the least economical for high cost players like full service brokerage firms, also raising doubts about the banks’ argument. Someone with a small balance needs to keep transaction costs down even more than investors with bigger balances. And while they’d presumably want to preserve their profits with the small fry, I’d bet their real aim is to preserve their freedom of action with larger accounts, which is where the real juice is.
Similarly (and maybe I am hopelessly old fashioned) I have never liked the retail brokerage model (it probably has a lot to do with having worked on Wall Street). If you need advice, pay for advice and get low cost execution. Or if you are too small to afford advice, do some homework on asset allocation and buy index funds (one big caveat: read Benoit Mandelbrot’s The Misbehavior of Markets. Everyone needs to recognize that the tenets of financial economics underestimate the risk of markets and as a result, encourage too much risk-taking. Any standard advice on what level of stock holdings are desirable needs to be dialed down. Rule number one of investing is preservation of capital, and that too often is ignored).
It was depressing but predictable that this Bloomberg story was one sided; this article replayed the arguments of SIFMA, the industry lobbying group. But it’s probably an accurate reflection of how the consumer has no advocate when financial rules are being nailed down.