Obama vs. Savers ???

“The White House moves to take away choices for middle-class investors.” The Wall Street Journal, 2/26/2015

This is the crux of an editorial in The Wall Street Journal (“WSJ”) castigating President Obama for his Administration’s attempt to force investment advisors to look out for their clients’ best interests instead of gouging them with high-fee products to the detriment of their 401(k) balances. I am an avid reader of The WSJ. I find their Saturday “Personal Finance” section a treasure trove of priceless information for the individual investor. Columns by writers such as Jason Zweig and Morgan Housel have saved investors an inestimable amount of money with their sage advice. I am also not a huge fan of our current president. I harbor no personal animosity toward him, but I disagree with many of his international and domestic policies. That being said, I support the president on this issue and believe the hardliners of the Journal’s editorial section have gone too far on their ride on this crazy train. Let’s look at some of their arguments for defending the freedom of middle-class investors, by preventing them from being required to use an advisor who is looking out for their best interests. With friends like these, who needs enemies?

“It claims workers are particularly vulnerable to this “conflicted advice” when they roll over their 401(K) workplace savings into retirement accounts.” This is a very serious issue. Often workers are seduced into leaving low-cost employer-sponsored plans, which offer institutional pricing and features such as Stable Value Funds. They are coerced into transferring these funds into high-cost mutual funds with sales loads or expensive variable annuities with steep surrender charges. Regulators are aware of this issue and it has become a priority of the SEC to put an end to this practice. While the writers of the editorial page may believe in extreme laissez-faire and a self correcting market, explain this to former members of the excellent government thrift plans who are now stuck with products that could cost them over 10% of their principal to get out of. Like Michael Corleone’s sister said to the hopelessly naïve Kay in The Godfather, if you don’t believe me, “Read the papers.”

“Brokers are already heavily regulated…which imposes myriad rules to prevent fraud, ensure that fees are disclosed and protect clients from unsuitable investments.” Many brokers are self-regulated by FINRA. This organization is financed by the brokers themselves. You can draw your own conclusions on this. Clients also give up their right to sue brokers in most agreements and must choose arbitration. Often the deck is stacked against the investor in these proceedings. If investors were protected against unsuitable investments, why are retail clients still being sold private placements, non-publicly traded REITs, and variable annuities in their tax-deferred accounts; and mutual funds with sales loads of almost 6%?? Obviously the current rules are not suitable and need the reinforcement of a fiduciary standard.

“The implication is that investors could boost their returns if they avoided conflicted advice and listened to only fiduciaries.” The WSJ hires some pretty smart people. Their knowledge of basic math should make them realize the how preposterous this particular statement is. If an investor pays an upfront fee of 5.75%, and fund fees of 3% (if you include trading costs in a taxable account), they are going to have a rough time generating a positive real return with an average inflation rate of 3.5%. If a fiduciary charges 1% and uses low-cost index funds, the real return in this instance will trounce the conflicted advice. It is not an implication, it is numerical fact. Ask Warren Buffet about investment costs. There is a reason he said his wife should buy index funds if he predeceases her.

“What will happen to fiduciary fees in the absence of competition from traditional brokers?”The implication is fiduciaries will become a monopoly and start gouging their clients like many brokers do. There are two things wrong here. First, the definition of a fiduciary is to look out for a client’s best interests above all else. I am assuming that charging clients 4% fees on their funds would violate this principal. Second, The WSJ is assuming these brokers would just go away and sell used cars (not exactly a stretch). Would some of them possibly become fiduciaries themselves and drive prices even lower? As they say, if can’t beat them, join them.

“The most damage may come from the services never provided. As heavily as they already are…. Heightened liability may convince them that the best course is to say nothing, especially to investors with small accounts that can’t generate much revenue anyway.” Basically what they are saying if brokers are not allowed to rip off small investors they won’t service them. Since many small investors are serviced by brokers the same way John Dillinger serviced banks, this is a huge positive. Small investors can now go to numerous Robo Advisors and pay a fraction of what they did in order to have the “privilege” of working with a broker. In fact many fiduciary RIA’s are making this a part of their practice in order to give the little guy a chance.

The fact that President Obama wants to help out middle class investors should be lauded not criticized. Papers like The WSJ should encourage this for the simple reason that if people think the game is rigged, they won’t play. Fewer players mean less advertising revenue for a financial publication. It seems the editorial board is committing a cardinal investing sin here. They are letting their political beliefs interfere with a sound investment process. Like their nemesis, President Obama, likes to say, “They are on the wrong side of history.”