I would say that it is pretty well recognized that for some time now workers have been responsible for saving for their own retirement. As an article in the New York Times puts it, “The system of retirement savings as it exists today actually requires any American hoping for a comfortable standard of living to have a fair amount of foresight and financial savvy to save enough and put investments in appropriate vehicles.” Most people would agree that they are ill-prepared for this task. Consequently working Americans often seek professional help from financial advisers of various sorts. However, purveyors of financial advice are not created equal. Some advisers have a fiduciary responsibility to put the interest of their clients first while others are not held to the same standard. The White House released a study, The effects of Conflicted Investment Advice, saying that certain practices are costing retirement investors about $17 billion a year as a result of excessive fees and hidden conflicts of interest. The White House, via the Department of Labor, is developing new rules that would declare that retirement investment advisers have a fiduciary obligation, that is, they would have to put their clients first. Link to the White House web page for more detail on the overall rationale for the new rules.
Just this morning John Authers in the Financial Times wrote an article citing a recent series of studies by Mebane Faber in his book, Global Asset Allocation . (Mebane Faber is managing director and portfolio manager at Cambria Investment Management, where he manages portfolios based on quantitative strategies.) In the book, Faber examines several accepted allocations including those recommended by Mohamad El-Erian and Rob Arnott. The essence of Faber’s findings is that based on a reasonable asset allocation, performance results are similar across the various allocations over the long run. The “gorilla” in the room is adviser fees. Fees reduce portfolio performance very significantly. Faber says “In one shocking example, we find that the best performing strategy underperforms the worst strategy when we tack on advisory fees.” So clearly what advisers extract from their clients greatly reduces the long-term return for the investor.
The chart shown above offers a simplistic illustration of the impact of fees on a scale that individual investors can identify with. I started with $100,000 and assumed an annual return of 5% and an adviser fee of 1.5% and used Excel to compute a two series of annual balances, one series with the fee and the other without. I added the return and subtracted the fee at the end of each year for the ‘with fee’ series. The red line shows the ‘no fee’ trajectory and the blue line the ‘with fee’ trajectory. The ‘no fee’ balance at the end of the 25 year period is $338,635 versus $232,080 for the ‘with fee’ balance. You can characterize this two ways. The ‘no fee’ result is almost 46% more than the ‘with fee’ total or the ‘with fee’ result is about 31% less than the ‘without fee’ total. The fees are a double whammy really. Not only does the investor pay almost $61,000 in fees over the 25 years, but has less money that is working to earn returns during the entire period.
Apparently, there is significant push-back against new regulations from the financial services industry and from some members of Congress. Saving for retirement is difficult enough for most people. Returns on investments today are low by historical standards which exacerbates the difficulties. How is it that allowing some types of financial advisers to foist substandard returns on their clients can be good for Americans and for the country as a whole?