Imagine your career winding down and being presented with these two offers: $1,500 a month for the rest of your life, or a $350,000 lump sum that you can use however you see fit. Which would you choose? How would you make sure you lived comfortably for the rest of your life?
In 2002 Phil Ashburn, working for what was at the time Pacific Bell telephone company, was presented with just this choice. He spoke to a financial adviser who had done business with Pacific Bell, and based on her advice decided that the lump sum was his best chance to make sure that he not only had enough money to live well, but could also leave some money behind for his family. The adviser assured him he’d “never go broke, always have money.” He placed his money in an account she recommended and chose to take out $2,700 a month.
For awhile, things seemed normal. Ashburn was reassured by monthly update letters from the adviser, who told him to stay the course. But then one month he got a call informing him that due to a merger, he was being assigned a new adviser. And that new adviser had new ideas for Ashburn’s retirement account: Switch to an actively managed account. The fees would be higher, but so would be the returns, he promised.
Ashburn tried to run this past his previous adviser, but she had left the state, having turned over her client list to this new person. Without getting a second opinion, Ashburn let his new adviser move his retirement nest egg into a new variable annuity, for which the adviser would collect $4,800 a year in fees.
“We lost hundreds of thousands of dollars as a consequence of this advice,” Ashburn said as he participated in a panel on the “retirement savings drain” convened earlier this week by Sen. Elizabeth Warren (D-Mass.) and Rep. Elijah Cummings (D-Md.) as part of their Middle Class Prosperity Project.
The forum, which was joined by Reps. Maxine Waters (D-Calif.) and Robert Scott (D-Va.), concentrated on the bad advice that Americans are receiving from financial professionals who only seek to line their own pockets through hidden fees, high costs, and lousy products. These advisers siphon off nearly $17 billion per year from investors.
“It’s hard enough for Americans to save for retirement without having to worry about whether they’re getting retirement advice they can depend on,” Warren said. “But because of outdated laws and loopholes big enough to drive a truck through, it is perfectly legal for some brokers and financial advisers to take kickbacks, prizes or even vacations for selling lousy products to unsuspecting customers.”
The forum came on the heels of a February report released by the White House warning against a potential conflict of interest in the way that financial professionals are paid and the products that they endorse for their clients. In the report it states, “financial advisers are often compensated through fees and commissions that depend on their clients’ actions. Such fee structures generate acute conflicts of interest: the best recommendation for the saver may not be the best recommendation for the adviser’s bottom line.”
Christopher Lombardo shared with the panel his own experience as a victim of unscrupulous advisers. He saw the nest egg of his parents-in-law, the Toeffels, slowly deteriorate as his father-in-law went through hospitalizations and suffered from Alzheimer’s. The Toeffels were advised to put their money in high-fee accounts that assessed a 7 percent penalty every time they had to withdraw money to respond to medical emergencies. The cost of the financial advice cost the Toeffels $50,000 in fees, while the funds remaining in the account were not growing at all. Worse, if they had pulled all their money out all at once, it would have cost them $45,000.
“Right now, the law does not require all financial advisers to act as ‘fiduciaries,’ which means they are not required to serve the best interest of their clients,” said Cummings. “Instead, current regulations allow some financial advisers to steer people to investments that generate high fees for the advisers–rather than the highest returns for the clients.”
The fact that many Americans’ investments are not handled by fiduciaries is a relatively recent trend. For decades, many Americans were granted pensions from their employers, who acted as fiduciaries in managing the pension plans of their employees. Twenty-eight percent of Americans were on defined benefit pension plans in 1979. That number fell to three percent in 2008, according to the Employee Benefit Research Institute. In that time, there has been a rise in defined contribution plans, that are typically managed by a broker.
For many of life’s biggest decisions, Americans are legally put into fiduciary relationships. Buying a home? Lawyers are required to be fiduciaries to their clients. Going to the hospital? Thankfully, doctors are legally required to look out for their patients. That duty does not apply to financial advisers, leaving millions of Americans looking to navigate the difficult world of finance on their own, or hope they find an adviser who looks out for their interests, despite this not being a requirement.
The benefits of requiring fiduciary duty of retirement brokers is pointed out in an experiment by presenter Antoinette Schoar, a professor at MIT, and two colleagues. They created an experiment with 250 “mystery shoppers” who were looking for investment advice. With some mystery shoppers, they had them presented with mistaken information and differing types of portfolios. What they found caused concern.
“The advisers seemed to exaggerate the existing misconceptions of clients if it made it easier to sell more expensive and higher fee products to them,” Schoar said. “In addition, advisers strongly favored actively managed funds over index funds… This is exactly counter to the insights from finance research, which suggests that the average investor should choose low-cost index funds.”
However, there was some hope in her study. “We found that advisers who have fiduciary responsibility towards their clients provided better and less biased advice than those who are merely registered as brokers. The former were less likely to move people away from index funds and to reinforce erroneous beliefs about the market.”
So, a person who finds an adviser who assumes a fiduciary duty has a better chance of receiving investment information that would benefit them than if they went to one that did not assume a fiduciary duty.
In order to combat the conflict of interest that financial advisers may have in giving investment advice, President Obama and the Labor Department have proposed a simple fix: require all retirement advisers to adhere to having a fiduciary duty to their clients.
Warren seems to be on board. “We have a chance, a real chance, to do now what we should have done years ago. We have a chance to end the kickbacks, the free vacations, the fancy cars, and all the other incentives to sell lousy products to unsuspecting customers,” she said. “We have a chance to ensure that all investment advisers, and not just some of them, are looking out for the best interests of the people they serve.“