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The conflict of interest rule for advisors issued by the Labor Department earlier this month promises greater protections for investors.
That is good news, but there is a catch. The change will not take effect until at least April 2017, and a new Congress or president may try to roll it back. So for now, consumers still need to be aware of what drives their advisors' recommendations on investing their retirement savings.
"There are a lot of people today who don't even know that they are not getting the best advice," said Nancy LeaMond, executive vice president of social impact at AARP, which advocates for older Americans.
Even people who already have advisors may not be aware of what standards apply in their interactions. The RAND Corp. surveyed more than 1,000 adults about investing and investment advisors, and found that more than 40 percent believed incorrectly that brokers are required to act in clients' best interest.
The researchers also found that the subjects of their survey tended to be wealthier and better educated than the population at large, which suggests the report may have overstated the level of the general financial understanding.
As a result, people with advisors would do well to ask them these questions:
1. How do you decide on the investments you recommend for my IRA? Are you looking for choices that are "suitable" or options that are in my absolute best interest?
Under current rules, a certified financial planner or registered investment advisor is required to put clients' best interests first and meet what is known as the fiduciary standard. But a broker or a broker dealer only has to point to suitable investment options. Those choices could generate higher payments to the broker and worse performance for the investor, but as long as they are generally suitable for a client's profile, a broker can recommend them.
A broker could still recommend such investments under the new rules, but would have to disclose any conflicts of interest. And broker and client would have to sign a "best interest contract exemption" indicating that both parties are comfortable with the arrangement.
2. What standard do you use to recommend investments for my taxable investing accounts, and how do I know when you are putting my best interest first and when you are looking for merely suitable investments?
The new rules could lead brokers to follow different standards depending on the type of account you have. For a retirement account, they will have to put your best interests first. But the Labor Department rule does not apply to other investments, so your broker will not have the same obligations when advising you on those accounts. Make sure you know what is behind all the recommendations you receive.
3. I understand the new rule on investment recommendations will not take effect until at least 2017. What changes can I expect to see in how we interact, and when?
Your advisor has a year to implement the new rule, but that does not mean he or she will wait that long. Expect to see announcements and forms coming your way, and make sure you understand exactly what they mean.
One example: the best interest contract exemption. If you and your advisor sign this, the firm can continue to use compensation practices now in place, like commissions, provided they follow a basic fiduciary standard and tell customers about any conflicts of interest.
4. Please explain the education and training you went through to obtain your professional designations.
Many advisors hold hard-to-earn certifications like certified financial planner, which entails hours of courses and an exam developed under the oversight of the Certified Financial Planner Board of Standards. But there are more than 160 professional designations listed on the website of the Financial Industry Regulatory Authority, and a number of them require only that the applicant take a few courses and/or pay a fee.
"This proliferation of designations, especially those geared to the retiree market, are shameful in their obvious objective to simply provide a marketing tool for salesmen," said Clark Blackman II, a CFP and president and CEO of Alpha Wealth Strategies.
Investors who are looking for an advisor have additional questions to ask, including:
1. How much do you charge, and what is it based on?
An advisor who is paid a fee and does not receive commissions on certain products is less likely to have conflicts of interest.
2. What, if any, other products do you sell besides investment advice?
Financial advisors can sell other products, like insurance. That can be fine, but make sure you understand how they are compensated for everything and any potential conflicts of interest that can ensue.
3. When you make recommendations, will they be in my absolute best interest or will they be one of many suitable alternatives?
A year from now, all advisors will be required to make recommendations based on a client's best interest, and must disclose any conflicts of interest. But for now, it is a good idea to know what is driving an advisor's choices.
4. Please provide me with a written estimate of my total investment costs with you in my first year, and explain how they are calculated. Please also estimate for me what your firm will likely earn if I become a client.
This question, suggested by Blackman, offers another way to find out what is driving an investor's recommendations.
Another good idea is to look at BrokerCheck, operated by the Financial Industry Regulatory Authority, to make sure the advisor has not been the subject of any regulatory or criminal sanctions. Even your longtime advisor can run afoul of the rules and it is a good idea to be watchful, experts say.