You know you pay stock brokers too much for investment advice. That’s a given. But can we put a number on the cost of their often-conflicted advice?
Try this on for size: Up to $17 billion a year, according a White House memo leaked to the press.
The “conflict” comes in when stock brokers give you investing ideas. Under the law, they don’t have to act in your interest while doing so. They might, of course, but nothing compels them to.
In short, that hot new mutual fund your stock broker thinks is a winner might be great, but it might be a dog loaded up with fees you shouldn’t be paying. Your broker nevertheless gets a sales commission from the mutual fund for signing you. Where do you think his loyalties lie?
The real cost to investors of stock broker conflicts is staggering. Conflicted advice alone accounts for between 50 and 100 basis points a year of underperformance. That’s right, you pay a stiff fee and in many cases get put into an investment that will lag the market just the same — the exact opposite of what you expected.
Add fees and conflicts of interest together and what do you get? Years upon years of weak results. Your stock broker makes money. The mutual fund company makes money. Your retirement stagnates. Researchers found that for every $1 in extra commissions a stock broker earns from mutual funds they direct an extra $14 into those funds.
The poorer-performing mutual funds thus have an incentive to pay better commissions, and the brokers just go along. As the New York Times points out, several countries have banned pay-for-play schemes, including Australia and Britain, because they so badly damage investor returns.
There oughta be a law, you might be saying about now. Well, the Department of Labor has been struggling for years to enact such a law. New rules would hold stock brokers to a fiduciary standard when doing business. My firm, Rebalance, is a Registered Investment Advisor, so we already meet the standard.
Under a fiduciary standard backed by law, investment firms would be required to put the interests of the client ahead of the interests of the firm. Sounds so simple and easy to understand, which is why Wall Street is fighting tooth and nail to keep it from happening.
If stock brokers were required to meet the fiduciary standard, as Labor and the White House would like, many would be wiped out. Unable to gather commissions from mutual fund promoters, they would instead have to survive on the quality of their investing guidance. You would suddenly see a load of people leaving Wall Street for law school, real estate, who knows, maybe retail.
Some would stay but find themselves living far more constrained lifestyles. Massive bonuses would deflate. Seriousness and results would predominate in the field of investment advice. Simpler, more transparent fee structures would become normal and conflicts of interest would evaporate.
Who would sell mutual funds? It doesn’t matter. People should buy an investment product based on its track record, and that record should be one of low cost, clarity of mission and results. That’s easy to find out on your own.
Most probably, the index fund business would grow larger at the expense of the actively managed mutual fund business. You really can’t get much more transparent than that. The fees on index funds are extremely competitive and their performance is incredibly predictable.
Will Washington finally set the bar higher for stock brokers and Wall Street? Let’s hope so, and soon.