If you’re not on a path to a secure retirement, the White House suggests it’s because an evil broker is ripping you off.
If you’re a Democratic policy maker worried about retirement savings for the little guy, would you deny millions of small savers access to financial advisers in ways that could cost them $80 billion in the next market downturn? Would you ask working families to pay more to keep the adviser they have?
The obvious answer to both is no. But the White House and the Labor Department have teamed up to propose a new “fiduciary rule” on brokers and advisers serving individual retirement account investors, which would produce precisely these unintended consequences.
The White House starts with good intentions—a concern that too many Americans are unprepared for retirement, and need to save more, and invest wisely. But instead of urging Americans to save, the administration has launched a campaign against a phony villain. If you’re not on a path to a secure retirement, the White House implies, it’s because evil financial advisers are ripping you off.
Secretary of Labor Thomas Perez insists that small savers would be better off working with “robo advisers”—computer-programmed advice delivered by email or text message—than with human brokers who get paid commissions by investment firms, because this renders their human advice “conflicted.” The Labor Department has proposed rules to effectively ban this form of compensation.
No one objects to a requirement that financial advisers act in their client’s “best interest.” And certainly, as with any profession, there are bad actors who need to be weeded out. But by decreeing that all brokers who receive commissions are automatically suspect, the White House and Labor will end up hurting the people they aim to help.
Two main factors explain why. First, contrary to conventional wisdom, commission-based compensation is usually the least costly way for small savers to get valuable advice. Second, by being indifferent as to whether people get advice from a human or a robot, the White House would doom working families to billions in losses.
Start with the price of financial advice. Today, millions of small savers choose to work with brokers, often paying something like a 2% sales charge (or commission) up front when buying mutual funds they plan to hold for a long time. Each year thereafter, under this model, the annual cost of the broker’s advice is 0.25%.
If commissions are banned, many brokers will ask these savers to move to a “wrap fee” arrangement instead. This fuller-service model, designed for wealthier clients, runs more than 1% of assets every year. By our calculations, a family with $100,000 in retirement savings would pay about $7,000 more in fees over 10 years under a wrap fee arrangement.
In other words, the Labor Department would ask small savers to pay much more to maintain a relationship with their broker for investments they already own (and on which they’ve already amortized the original sales charge). No wonder some Wall Street firms have shrugged at the rule, saying they’ll just have to find a way to get by with higher fees.
Other brokers, however, will find it uneconomic to continue serving small savers because of new costs and legal risks. Some defenders of the rule say that’s no problem because “robo advice” can fill the gap for working families left to fend for themselves (or unable to pay higher fees). But while online counsel can help savers identify products, it is dangerous to conclude that advice delivered by human beings has no value.
As research from Vanguard has shown, brokers and advisers perform a vital service by keeping clients invested for the long-term, rather than trying to time the market. The decision to stay invested during times of market stress swamps all other factors affecting retirement savings. “Robo advice” is not a substitute. An email or text message in the fall of 2008 would not have sufficed to keep millions of panicked savers from selling, with devastating consequences for their nest eggs.
Expecting robots to safeguard the retirement security of small savers is the kind of policy hubris that could only come after a six-year bull market, when officials have forgotten that what goes up can also come crashing down.
Our conservative assessment in a new report (funded by Capital Group, a leading investment manager) is that the cost of depriving clients of personalized human advice during a future market correction—merely one of the many costs not considered by the Labor Department—could be as much as $80 billion, or twice the benefits the administration claims for the rule over the entire next decade.
There’s still time for facts to prevail, and for sensible ideas—like better transparency and disclosure of commissions—that can help small savers reach their goals. Without such a course correction, a new chapter in the long federal saga of unintended consequences may soon be written, and American savers will pay the price.
Robert Litan is a non‐resident senior fellow at the Brookings Institution and senior consultant to Economists Inc. Funding for this paper was provided by the Capital Group, which provides investment management services worldwide. The analysis and conclusions are solely those of the authors.