Hey Bob? It’s me! Say, have you heard of Enron?

Yesterday, the New York Times published a story (NYT has a paywall, get past it by googling the title of the story – “More Protection For a Nest Egg Has Some Brokers Upset” – and clicking the link from Google) about the financial services industry’s response to a proposal by the Department of Labor. The proposed rule would require that all financial advisors place their customer’s interests ahead of their own when providing investment advice.

“Hold up,” you may say, “Are you telling me that currently, financial advisors are not required to look after their customer’s best interests?”  Yes, that’s exactly what I’m telling you.  For the purpose of this discussion, financial advisors range from high end “concierge” advisors at big investment banks, all the way down to “kitchen table” financial planners and advisors.  At present, financial advisors can, and do, do any of the following:

• Press the investor to purchase funds with high expenses when an equivalent fund with very low expenses is available.
• Advise the investor to tie their assets up in illiquid and expensive vehicles like annuities when they are not appropriate for the investor’s goals.
• Collect a fee from the investor for advice, and on the back end, collect commissions from fund company for having convinced you to invest with them.
• Suggest an asset allocation inappropriate for the investor’s age, advising them to invest in more aggressive and volatile funds than conventional wisdom dictates.

On September 10th, 2015, the Congressional Committee on Financial Services held a hearing on the proposed rule.  Mercer Bullard, from the University of Mississippi Law School, and founder of non-profit investor advocacy group Fund Democracy, provided testimony which calls out many of the ways in which the fund companies incentivize financial advisors to give their customers faulty or harmful advice in order to maximize the advisor’s own returns.  All of the above is why there’s a fairly good chance that…

Your Financial Advisor is Ripping You Off (Probably)

Bullard also testified in the hearing itself (linked above) and made the sensible point that if a certain behavior is more highly compensated, more of that behavior will occur.  Advisors are making over twice as much to promote actively managed stock funds versus short term bond funds.  Further, many of the compensation schemes increase the amount of compensation based on hitting certain sales goals.  So if an advisor hits his or her sales goal, his or her compensation for all prior sales for that year is increased, and he or she receives a large lump sum at that time.

I am sorry to say it, but there’s a pretty good chance this includes your advisor.  Yes, that includes the person who comes to your work on behalf of your 401(k) company, and yes, it includes the advisors from the guy with the radio show and books who helped you get out of debt.

In an effort to remain apolitical, some congresspeople in the hearing are clearly for the rule, and others are clearly against it.  The main argument against is that it will cause advisory firms to stop offering their services to the average American.  Let me tell you why I think this is a bogus argument:  You do not need a financial advisor.  You can do this yourself.  You don’t have to be very financially or mathematically inclined, and you don’t need to invest countless hours in research.  I’ll explain in a little bit.

The rule may or may not ever become law.  Because it’s not currently under consideration, and because there’s no guarantee that such protections will ever exist, it’s important that every single individual investor be armed with this knowledge.

Some Personal Finance Blogs Are Complicit

Many personal finance blogs, including this one, would like to earn money in return for producing interesting content.  The unfortunate truth of the matter is that the most profitable sources of income for personal finance blogs are financial services companies.  As a result, while there are many personal finance blogs with integrity and a genuine desire to help the reader, there are others that promote services which enrich the author at the expense of the reader.  In the personal finance blogging world, this is what’s known as a dick move.

You should always ask yourself whether a service being promoted benefits the blogger.  I’m not saying you shouldn’t use anything promoted on a blog.  In fact, it’s the only way to support blogs that do attempt to produce interesting and original content in an ethical way.  I am just suggesting that you owe it to yourself to understand the relationship between you as a reader, the blogger, and the provider of the service.

I’ve written on this topic before, and my policy is that the only ethical way to make money is if a recommended service will get the reader to financial independence faster, and no less expensive equivalent exists.  So, for example, it would be inappropriate for me to suggest that you hire an advisor to pick stocks for you (and accept a referral bonus from them) when I sincerely believe that low cost, passive index funds are the most reliable and safe way to achieve early retirement.

How You Can Avoid Becoming a Victim

As an individual investor, your only defense is in educating yourself to eliminate the need for a financial advisor altogether.  The great news here is that if your financial advisor is ripping you off, you can probably fire him or her tomorrow and do the job yourself.  Wall Street has a vested interest in promoting the belief that investing is hard, and requires professional assistance.  The reality is that our retirement timeline is in decades, not years, and Wall Street has a terrible record of beating the market.  In short, over decades, basically none of the funds being aggressively sold to individual investors can beat the market.  Zero.

“If I can’t beat the market, then what good is investing?”

You don’t have to beat the market.  You just have to match it.  Over a hundred years of returns show us that inevitably, the US stock market goes up.  There’s huge potential in the developing world, and you can match that market too.  You should be investing in low cost (what’s called the “expense ratio,” and any fund you buy should be less that 0.25%), passively managed (maintains stocks in a certain proportion, and not based on the picks of a fallible human) index funds (funds hold all of the companies in the index they track).  As a result, you will perfectly match the returns of the market going forward.  The long term average returns of the US stock market since inception are about 7-8%, adjusted for inflation.  By the way, you don’t just have to take my word for this.  One of the most famous and successful investors in history agrees with me.  Warren Buffett strongly suggests that you buy index funds with these same attributes.

It’s okay if you’re still confused.  If you’d like some actual recommendations of funds that meet those requirements, check out the Early Retirement Infographic.  For a deeper dive, my favorite internet resource is the JL Collins NH stock series— it’s an entertaining read that will take you from zero to hero in a couple night’s reading.  It’s indispensable.

My advice?  If your advisor is suggesting that you purchase funds with a “load” (up front fee), which or actively managed, or which have an expense ratio over 0.25%, it’s time to give them the boot.

Think I’m way off base? Think I’m right? Let me know in the comments below!  Also, please consider sharing on Facebook, Twitter, or Reddit.