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Friday, May 12, 2017

Shifting Ground in the Battle for a Fiduciary Standard

The Trump administration has moved aggressively to roll back the Department of Labor's fiduciary rule.  In a move that likely cost investors billions in lost gains, the new administration first delayed the regulation by moving its effective date back sixty days to June 10th.  More administrative delays may come. Press reports indicate that President Trump's freshly confirmed Secretary of Labor Alexander Acosta has "made stopping the measure his top priority."

With federal investor protection measures stalled, states may soon play a larger role.  Nevada has pending legislation designed to impose a fiduciary standard at the state level.  If these efforts succeed, they may increase protections on a state-by-state basis and outcomes for some.  

There is a real need to improve financial advice because far too many get bad advice.  In a local op-ed supporting the Nevada legislation, I explained how bad advice can cost investors:

The worst segments of the financial services industry oppose the bill because their high profits come from convincing savers to buy the wrong shares in the wrong funds. For example, Rydex sells an index fund tracking the S&P 500 with 2.31% annual fees (RYSYX). Vanguard sells a similar fund tracking the S&P 500 with 0.05% annual fees. The lower-cost Vanguard fund will always outperform Rydex because the funds track the same index. These fees add up to significant costs over time.

According to the American Institute for Economic Research, a decade-long investment of $100,000 would have accumulated $204,758 in the Vanguard fund and only $163,619 in the Rydex fund. The high fees create a $41,139 difference over time. Despite this, many stockbrokers recommend Rydex because it kicks a significant percentage of its fees back to the financial adviser. While Rydex provides a glaring example, financial advisers often steer clients toward suboptimal decisions in countless other instances.

Astonishingly, the fund has over $270 million in assets.  This is not the only high-fee index fund in the market.  Most investors do not behave as rationally as financial theory expects. Imagine what a scrupulously  honest financial adviser would have to say when recommending this fund:

I think you should put $100,000 in Class C shares of the Rydex S&P 500 Index Fund.  It's about 46 times as expensive as the Vanguard fund tracking the same index.  If the next ten years go like the last ten years, you'll end up behind the Vanguard fund by over forty grand--that's enough to buy a Corvette.  I still think you should buy it because the Rydex fund uses its fees to pay me for the excellent services I provide you as your financial adviser.  Think about how much you like it when our client-management system cues me to send you birthday and holiday cards!  These fees allow me to build our trusting relationship so I can continue to guide you with wise financial decisions in the future. While I won't get $4,000 a year personally because of the fees that go to Rydex, that is how much you're effectively paying.  So what do you say?  Corvettes are overrated anyway.

Posted by Benjamin P. Edwards on May 12, 2017 at 04:20 PM | Permalink


VFIAX and VOO now have an expense ratio of .04%.

Posted by: Brad | May 13, 2017 8:24:27 AM

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