Fiduciary rule, and where investors lose big money

February 10, 2017

You may have heard that the "Fiduciary Rule" from the federal government, intended to protect investors from conflicts of interest from financial advisors, has been postponed by the current administration. Yesterday morning a court ruled the postponement invalid, leading to general uncertainty.

The rule is a piece of work. Stretching over 1,000 pages, it's more Moby Dick at this point than rule, minus the elegant writing and ferocious whale. I'm not sure it would have done a lot if implemented: by the time it got through the meat-grinding process of creation, sprinkled with the seasoning of countless lobbyists, it was heavily watered down, narrowed in scope, and confusing.

The essence of the rule was "a client hires an advisor to act in their interest. Their logical assumption is that the advisor will do so. The advisor should do that and not take commissions from funds the advisor uses so that he/she can go heli-skiing in British Columbia." The financial industry disagreed with this common sense and got nervous about what ethics would do to profits, so they fought it tooth and nail.

This behavior from the financial industry is embarrassing. But it is widespread. Almost all of the major firms are doing this to clients. If you have your money in a big firm, or with the 77% of advisors that are paid via "commissions," you're on the receiving end of this behavior. That is neither a fun nor profitable place to be.

One Day In July does not belong to that club.

Doing something good for investors, Charles Schwab, the custodian for One Day In July (the firm that holds our clients' money), lowered trading fees from $8.95 to $6.95 per trade this week. Because these fees are posted publicly, and consumers can understand them, they are one of the few areas of cost-cutting in finance. Competition and clarity work wonders.

It's striking to us, when we start up with a new client, just how much trading cost there is in cleaning up the work from their former firms and advisors. Active mutual funds will often have a $35 to $50 fee (and that's at Schwab!) vs the $6.95 per trade that we incur.

I want to put this in perspective. As bad as the high fees are, and as much damage as they are doing to investors, it's not the largest problem. The real "elephant in the room" happens not to be in the room: it's the poor performance that fund managers, and advisors, deliver. This has a larger influence over time than fees.

Where you really "lose" money as an investor is by not getting what could have been had. Sometimes people refer to this as an "error of omission" or sometimes "opportunity cost." The financial industry loves it, because 99% of Americans never realize what they could have gotten with their capital. If you don't realize what you should have had, you don't get upset when it's taken away.

For example, here is the annual return on the S&P 500, dividends included, since the financial crash.

For most people, if their financial manager said "I bought some mutual funds that concentrated on large U.S. companies, and they returned 8% last year," they would think they are doing well. But two thoughts should have come to mind: 1. "Did they pay me my dividends, because I'm the owner" and 2. "That's pretty bad, because the index returned 11.96%. So these actors got paid to lose me a lot of money, relative to where I should have been." This performance gap destroys wealth quickly.

If you had $250,000 on January 1 2009 (which was not the market bottom) and had put it into the S&P 500, using the compounding above, on December 31 2016 you would be at $753,670.49 in just 8 years. I am not seeing anything remotely like this in inbound work from new clients - accounts are generally flat or up a little. The difference went to the fund managers.

The One Day In July model equity portions performed roughly in line with the numbers above over the time period. Some indexes did better, some created drag. For various reasons, this was a difficult time period to match or beat the S&P 500. Academic research shows our equity models should outperform the S&P 500 by 1.5% to 2% per year and I remain convinced the reasoning is solid. We cannot know for sure what the future brings.

If you or your acquaintances are tired of making mutual fund managers and advisors rich while your returns are mediocre, get in touch. We fix that.