fiduciary adviser

Each year, Russell Investments does a nice job calculating the value of working with an investment advisor. They recently estimated the value added as a little more than 4%.

This is the additional percentage return that investors can expect to receive by working with an advisor compared with going it alone, and includes the following services:

  • Construction of a financial plan;

  • Basic investment advisory services;

  • Tax efficient investing consulting;

  • Help avoiding behavioral portfolio management mistakes; and

  • Annual rebalancing.

However, I believe that Russell Investments has left out a number of important elements that make working with a fiduciary adviser much more beneficial than working with a non-fiduciary advisor.

Yes, there is a difference between an investment adviser acting as a fiduciary for advice given and a non-fiduciary investment advisor. That difference is outlined below.

The difference between an advisor and adviser

I’m not trying to be cute. There really is a difference between investment advisers, spelled with an “er” at the end, and investment advisors, spelled with an “or.”

Here it is.

Investment advisers are employed by Registered Investment Advisers (RIAs) (my firm is an RIA) and are required by the Investment Advisers Act of 1940 to act as fiduciaries for the advice they share with their clients. They are the only investment professionals legally allowed to call themselves investment advisers.

Investment advisors, typically employees of banks, brokerage firms and insurance companies, are considered salespeople by the Act. They are NOT required to act as fiduciaries for the advice they share, since that advice should be incidental to the sales process. As a result, most do not act as fiduciaries for the investment advice they provide.

These individuals are not legally able to refer to themselves as investment advisers. Instead, they have decided to refer to themselves using a slightly different spelling of the word substituting an “or” for an “er”. Nearly everyone seeking investment advice is unaware of the difference.

Should you care whether your investment adviser is a fiduciary? Absolutely. It is the most important decision you will make when hiring an adviser. Here’s why.

Why it’s important that your adviser is a fiduciary

Investment advisers are required to put their clients’ interests first when providing advice. Investment advisors not acting as fiduciaries, typically working for banks, brokerage firms and insurance companies, are not.

Non-fiduciary investment advisors are salespeople selling their firm’s products and services and, as a result, tend to recommend investments that pay them more, whether or not they are the best options for their clients.

Investment advisers acting as fiduciaries must always put their clients’ interests ahead of their own. They are legally required to recommend the best options available for their clients, regardless of what they are paid.

As you might imagine, there is a significant difference between the quality of the investment advice that investors receive from fiduciary investment advisers and salespeople.

Can the difference be quantified? I think so.

Estimating the added value of working with a fiduciary adviser

1. No soft dollars

One way advisors can get paid is by accepting soft-dollar, or 12b-1, payments from mutual fund families for recommending their funds. Most fiduciary advisers do not accept these soft-dollar payments. However, most non-fiduciary advisors do.

Eliminating soft-dollar or 12b-1 payments can reduce the expense ratio of a mutual fund by anywhere from 25 to 75 basis points. The additional returns achieved by using a fund with a lower expense ratio flow directly to the investor.

Add another 50 basis points for using share classes that do not have 12b-1 payments tied to them:

4% (Russell Investments’ advisor value) + .50% = 4.50%

2. Lowest-cost share class

Investment advisors working for banks, brokerage firms and insurance companies are required to recommend their employers’ investment funds first to their clients — regardless of whether these investments are the lowest-cost, best-performing options.

Investment advisers working in a fiduciary capacity cannot first recommend inferior funds to their clients. They must make the best recommendation possible for their clients. As a result, they generally recommend the lowest-cost share class of any investment. The difference in cost can be an additional 25 to 75 basis points.

Add another 50 basis points for using the lowest-cost share class possible for each recommendation:

4.50% +.50% = 5.00%

3. Lowest-cost broker/custodian/trustee

If you are working with an investment advisor from a brokerage firm, guess where your assets will be custodied and which firm will be doing the trading? If you work with a fiduciary investment adviser, he/she can evaluate and choose the lowest-cost broker/custodian/trustee available.

Think order execution at a brokerage firm isn’t important? Take a look at this example.

Investors can save 25 to 50 basis points in trading costs and custody fees when working with a fiduciary investment adviser.

To be conservative, add another 25 basis points as a result of using more cost-efficient brokerage, custody and trust services when working with a fiduciary investment adviser:

5.00% + .25% = 5.25%

4. Competitive investment adviser fees

If you work with an investment advisor from a bank, brokerage firm or insurance company, I challenge you to accurately calculate what you are paying in investment advisory fees. Compensation to these advisors can flow from the firm that employs them as commissions, trails, base comp, bonuses, referrals and reimbursements. These advisors can also receive compensation from any one of 750 mutual fund families, a host of insurance companies and, of course, clients.

Fiduciary investment advisers typically only receive compensation from their clients.

Nearly all the clients my firm has taken on that were using non-fiduciary investment advisors were paying at least 200% of market in investment advisory fees.

If you can’t figure out how much you are paying your advisor because you don’t see all the compensation received, chances are good that you are paying too much. Fiduciary investment advisers have to charge market-competitive rates. Their compensation is transparent.

Because non-fiduciary investment advisors have a compensation stream that is not transparent and because fiduciary advisers have to charge market rates, non-fiduciary advisory fees can be up to 250 basis points higher.

Again, to be conservative, add 125 basis points when working with a fiduciary adviser:

5.25% + 1.25% = 6.50%

Why?

As shown in the table below, I believe that investors working with non-fiduciary investment advisors can increase the return on their portfolios by at least 2.50% by converting to a fiduciary adviser. Compounded over the 30 or 40 years investors save to fund their retirements, that can be hundreds of thousands of additional dollars.

Russell Investments added value of an advisor:                      4.00%

Plus eliminating soft dollars:                                                 .50%

Plus using the lowest-cost share class:                                .50%

Plus using the lowest cost broker/custodian/trustee:     .25%

Plus competitive adviser fees:                                          +1.25%

Added value of a fiduciary adviser:                                            +2.50%

Total value of a fiduciary adviser:                                                 6.50%

In addition, working with a fiduciary adviser can eliminate all conflicts of interest, resulting in higher-quality investment advice.

Why would anyone ever purchase investment advice from an advisor who isn’t a fiduciary adviser?

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About the Author

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs, and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on nearly a half billion in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.