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Don't Feel Bad for Large Brokers


Recently there has been much discussion in the media about the new "fiduciary rule" Obama imposed through SEC regulations.  Despite the industry outcry, this actually is a great thing for consumers and could go to end many of the practices that I find deplorable which are common in the investment advisory industry.

I grew up in West Texas, went to Texas A&M University, live in Dallas, and am a strange combination of libertarian and conservative.  It should come to no surprise to anyone that I am not a huge fan of the US's current president, the laws he's passed, and his general ideas on how economies should work (I believe I've used the term economic illiterate before).

 

I tell you this to emphasize what I am writing about today.  Many people do not know that in April 2016 that Obama and his regulators passed a new rule for retirement accounts -- known as the Fiduciary Standard.  The rule is not complicated, it simply states that if you give financial advice, including to all retirement accounts, you must put your clients' interests first.  Essentially all financial advisors are now fiduciaries to their clients.  The government is giving firms until January 2018 to comply.

 

When I read this back in April, I didn't think anything of it.  At my investment firm, we already require all employees to adopt above a fiduciary standard.  Doing no wrong by our customers is one of our principal beliefs.  Until these past few months, it never occurred to me how rare that position actually is, and I am absolutely amazed by the industry response.  People give advisors (me included) their hard earned money, their entire retirements, and trust me and my firm to do the best job we can to make sure their money is properly taken care of.  This doesn't mean losses may not occur, but it does mean we do everything in our power to perform to the best of our abilities.

 

In other words, I fully support the fiduciary rule (it feels strange to be saying that about an Obama policy).  Yet almost no large brokerage and investment businesses do.  Charles Schwab had to write down future earnings, their stock fell 20% in the wake of this announcement, and they have been an outspoken critic of the rule.  E-Trade similarly fell 20% in value and voiced the same complaints.  Today's Wall Street journal has a piece on Morgan Stanley stating that they are going to start charging exorbitant fees to all of the retirement accounts because of the new rule and warns that the rule will "punish" their customers.  What a load of bull.

 

What has happened is that the gigantic scam big firms pull on their clients is coming to light.  As CNN Money and Bloomberg noted in articles on this topic, most advisors are simply salesmen.  Many are not capable of putting a client portfolio, a mutual fund, optimal investment strategies, and so forth.  Instead they take a client questionnaire, put it into their "proprietary" software, and invest their clients as told to do by the software.

 

In practicality what this means is that Morgan Stanley will miraculously put you into Morgan Stanley mutual funds that have load charges and high management fees.  Charles Schwab will put you in Charles Schwab branded mutual funds that have load charges and management fees.  New York Life will sell you an annuity that has a gigantic commission that goes to New York Life and perhaps has an exit penalty.  Edward Jones, Merrill Lynch, LPL financial -- they all do the same thing.  And their brokers are paid based on how much they sell.  Essentially most brokers are car salesmen.  Unfortunately for the consumer these are not always "branded" funds either -- most mutual fund companies have high charges and pay high commissions on the sale of their products. 

 

This would be equivalent to going to a used car lot, a salesman wearing a Ford shirt comes out, and recommends you buy a used Dodge.  "Wow" you think, the Dodge must be great if a Ford guy is recommending it, so you buy it, only to find out later that Dodge paid the salesman a commission that was 50% higher than on the other car you were looking at, has higher mileage, lower blue book value (Morning Star), an that there are penalties if you try to trade it in. 

 

There is nothing special about a Morgan Stanley or Third Party high fee/high commission S&P 500 mutual fund or broad market fund.  Maybe it has a fancy name and flashy literature.  Maybe there is some great story behind it.  But if you put it toe to toe with a Vanguard Fund or low cost ETF that tracks the same, or similar, holdings, you quickly see that you are paying load charges and outrageous management fees. 

 

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The Fiduciary Rule eliminates all of this complete screwing over of customers.  Essentially if you tell your advisor that you simply want to invest in the broad market he can no longer sell you the product that pays him the most.  Rather he must put you in the product that is most advantageous for YOU.   This rule will utterly destroy all high fee/high load mutual funds that don't do anything other than track "US Large Cap," "US Mid Map," "US Growth," or sector funds because there are funds and ETFs out there that charge no loads and have very low management fees.  Many of these products don't pay commissions. 

 

For instance, Morgan Stanley's US Core Portfolio, MUOIX, is essentially a S&P 500 fund, its returns are VERY highly correlated with the S&P 500. 

 

But the Class A fund charges a 5.25% (FIVE POINT TWO FIVE PERCENT) load.  On top of that it has a 2.08% fee and expense ratio.  This is insane when you could get the same or better performance from SPY which has a 0.09% expense ratio.  Under the new laws, it will be an abject violation for any advisor to put you in MUOIX Class A over SPY.  If an advisor does, he or she is doing so for the sole purpose of screwing his customer by selling a high fee product over a substitute that is cheaper with the same or better performance.  If the Fiduciary Rule is not followed, the advisor could, and SHOULD be sued.  (As an attorney that defends businesses, I almost never advocate for suing a business -- but when a company is essentially lying to their customers in order to make more money off of them, go for it).

 

It amazes me how much this terrifies large firms and mutual fund companies.  I say good, and not only because as they lose investors I stand to gain them, but because what they have been doing for decades is simply wrong.  Your clients and customers TRUST their advisors, if they can't, the entire industry could crash.  Why use an advisor if they are going to just take every penny from you that they can? 

 

All of this does is concretely prove what I tell all of my customers -- be very careful when using a big name advisor.  Yes, big name advisors can be great.  I have a friend that works for Edward Jones that takes this rule very seriously.  That said, he's been written up for not selling the highest cost products.  Last December he was put on probation for constructing portfolios that matched what the client wanted, instead of what Edward Jones suggested.  When he sold products with no load charges, his paycheck was reduced.  He's strongly considering simply quitting.

 

I also am not trying to drag all mutual funds, advisors, or hedge funds in the dirt.  There are hundreds of higher cost funds with justifiable cost.  Complex strategies, illiquid investments, hedging, options, high volume trading strategies -- all of these cost money, manpower, and time to implement and can (and often do) have a place in a portfolio.  However, high cost mutual funds that merely track what you can get from an ETF, Vanguard Fund, or other low cost products will all have to go -- and these are the bread and butter of most advisors. 

 

I highly recommend pulling up your brokerage statement, going to google, and looking up the funds and products your advisor has placed you in.  If you are in a Class A, or other class with high front end load charges, in a mutual fund that is not really unique, fire your advisor and go get an honest one.  If you can't tell if a mutual fund can be replaced by a low cost, no load, ETF, have a third party advisor review it.  (Or call or email Lorintine Capital, cwelsh@lorintinecapital.com and/or jblom@lorintinecapital.com). 

 

I have reviewed statements and recommended that people stay with their current advisor.  I've cried at others.  One last example -- two weeks ago a Northwestern Mutual and Edward Jones client came in.  This client had about $3m invested between the two firms.  His total return from 2010 through the present was 0.2%.  That's not annual, that's total performance net of fees.  He has averaged, between loads and fund expenses, paying 6.5% interest per year.  His $3m investment has returned $36,000 before taxes and about $24,000 after.  If he had only been paying 1% to his broker and .5% in fund expenses, he would have earned over $1m over the same period.  Instead of earning it, he paid his advisors, through fees, that many. 

 

That's the power of compound interest and high fees.  Again to emphasize, this does NOT mean all high fee funds and products are bad.  They're only bad if they don't provide alpha, over time, higher than what they are bench marked against.

 

I don't know if I'll ever get over all of the complaints I've heard and read from the tens of thousands of fund salesman masquerading as advisors.  It just boggles my mind that someone can try to justify essentially stealing from their customers -- and it got me on board with at least one policy of our President.  Well done.

 

Please feel free to visit our website at http://www.lorntinecapital.com or email me at cwelsh@lorintinecapital.com or jblome@lorintinecapital.com.

 

If you have questions about your current portfolio, please feel free to contact Lorintine Capital at anytime.

 

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Guest Greg Gable

Posted

Hello,

I believe you have mixed up our point of view on this topic with someone else's.  Charles Schwab has been supportive of the principles represented by the DOL's new fiduciary standard on retirement advice from the beginning and at no time had to "write down future earnings" because of it.

Thank you.

 

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Well done. Excellent article. Well done and I agree totally with you. I got caught while I was busy working in a high pressure job. I now manage all my investments and only work with brokers who are 100% transparent on their fees and returns.

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14 hours ago, Guest Greg Gable said:

Hello,

I believe you have mixed up our point of view on this topic with someone else's.  Charles Schwab has been supportive of the principles represented by the DOL's new fiduciary standard on retirement advice from the beginning and at no time had to "write down future earnings" because of it.

Thank you.

Greg:

 

  You're actually incorrect.  Charles Schwab is running with it and placing adds and television commercials saying their advisors are fiduciaries and trying to take advantage of the rule change, as well as promoting their robo advisor (which is doing quite well, but I don't see them making money on that product until interest rates go up), but they did get hammered right after the announcement and had to adjust profits from the sale of overpriced products. 

 

They still increased revenue in the 2Q after the rule change -- but note that it did not have to be implemented yet.  Further, their price has largely recovered since the rule was announced.

 

In my opinion, that's because Schwab has done a better job than many in getting in front of the changed rule, from advertising, to getting rid of and creating new products.  But before the rule change, they ABSOLUTELY had disgustingly high priced products they pushed.  See the links below that talk about their losses and the products they had to get rid of.  In fact, they even had to remove loaded funds from their robo-advisor product.  Yes that's right, in a "low cost" automated trading system, they dumped investors into "proprietary" loaded funds that billed clients' accounts every time the position rolled or was changed.  Think about how wrong that is.  Your comment that Schwab has been "supportive" of the rule change is nothing more than big firm marketing.  They don't have a choice, they have to follow it, so they got in front of it and said they supported it all along -- that's just good marketing.  It does not mean they didn't follow the same vile system that all large brokers did before the rule.

 

See:  http://money.cnn.com/2016/04/06/investing/retirement-investing-fiduciary-rule/  (Schwab down 40%)

http://www.investmentnews.com/article/20160428/FREE/160429929/post-dol-fiduciary-rule-schwab-dumps-load-funds-as-advisers-yawn

(Schwab having to get rid of their high load products).

https://www.kitces.com/blog/schwab-intelligent-portfolio-and-blackrock-futureadvisor-under-dol-level-fee-fiduciary-rules/

(Schwab having to dump load funds from their ROBO advisors)

 

Also, you can read it directly from the horse's mouth in their opinion letter on the topic submitted during the comment period:

http://advisorservices.schwab.com/public/file?cmsid=P-8088461&cv0

While they supported the "general intent" behind the rule (e.g. advisors not steal from their clients -- hard to say you oppose that), they did oppose the impact it would have on retirement accounts by removing large load products.  In other words they were fine with a fiduciary rule, as long as the rule still allowed them to rip off their clients -- just like virtually every other large firm.  If Schwab really had been that much in favor of it, they would have implemented changes before the rule made them.

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3 hours ago, mccoyb53 said:

Well done. Excellent article. Well done and I agree totally with you. I got caught while I was busy working in a high pressure job. I now manage all my investments and only work with brokers who are 100% transparent on their fees and returns.

Thank you.  This is exactly why my firm simply forbids receiving commissions on any product we put investors into.  In situations where only loaded products are offered, we either decline the compensation and have it credited to the clients account, rebate it to the client (though this can cause tax or legal issues), or simply go find some other product.  Investment advisors job is to ensure all of the investments are in the client's best interest -- not the advisors and paying commissions on products sold to customers makes that almost impossible.  Its not that hard for an advisor to talk themselves into saying a particularly product is great when they receive a 5% commission on the sale.

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