This article was co-written by Jon Stein and Eli Broverman, Betterment’s co-founders.
By now, several months in, even a casual observer of the securities industry might be familiar with the Department of Labor (DOL) proposal to extend the fiduciary standard to anyone offering advisory services for retirement accounts. As for professionals, nearly a thousand have formally submitted written comments. This week, the DOL kicked off a climactic four-day marathon of public hearings, with 75 speakers scheduled. As a provider of fiduciary advice to more than 100,000 clients, we at Betterment have closely followed the debate.
The proposal is complex, and nobody can predict its precise impact on the massive and diverse retirement services ecosystem. Generally, the rules seek to subject commission-based sales professionals (i.e., brokers) who work with retirement accounts to a ‘do what’s best for the client’ fiduciary standard. Currently, they are subject to the less strict ‘suitability’ standard: essentially ‘do whatever is not plainly inappropriate.’ The latter permits recommending securities not because they are the best choice for the client, but because they generate the most revenue for the broker, while being ‘good enough’ to meet the client’s objectives.
Those who are already subject to the fiduciary standard—SEC-registered investment advisors (a group that includes Betterment)—are overwhelmingly in favor of the proposal. Given that the fiduciary model exists and prospers, the argument goes, the standard should be universal, and only unconflicted service is worthy of being called ‘advice.’
Predictably, those operating under the suitability standard are speaking out and spending aggressively to kill the proposal. Those organizations include the Securities Industry and Financial Markets Association (SIFMA), the industry group that lobbies on behalf of hundreds of firms, and The Financial Services Institute (FSI), which lobbies on behalf of more than 100 broker-dealers and 35,000 broker representatives.
Their main argument: Eliminating backdoor revenue streams (such as payments by issuers to promote certain products over others) will make servicing lower-balance accounts unprofitable, and given that such investors do not meet the minimums of traditional fiduciary advisors, they will have no access to ‘advice’ at all.
Automated investment advice, the rapidly growing service we pioneered at Betterment, serves as an emphatic counterpoint to this tired claim. Modern technology allows for true fiduciary advice to be delivered at unprecedented scale, with the expected quantum leap in affordability. We believe that services like Betterment, offering lower, transparent prices and superior experiences, will prevail in the market against heavily conflicted, legacy business models, regardless of the outcome of this particular proposal. However, the status quo will present considerable friction along the way, and the DOL’s proposed rule would likely accelerate industry reform.
First, consumers often cannot rationally choose a fiduciary adviser over a salesperson because they do not know there is even a choice to be made. Research shows that more than 75% of investors are not aware that two different standards exist for those recommending investments. They already assume that all such service providers have their best interests at heart (or don’t—they may equally trust or distrust all firms).
More than 75% of investors are not aware that two different standards exist for those recommending investments. They already assume that all such service providers have their best interests at heart.
To paraphrase Michael Kitces, a prominent fiduciary champion, consumers will take any ‘advice’ from a car salesman that ‘this is the best car for you’ with a giant grain of salt, absent any regulation that either standardizes the rules for all advice providers or makes the distinctions between them more clear. But the investment industry is a less intuitive context for most consumers. Over the decades, stockbrokers have increasingly adopted the ‘advice’ label, and consumers simply do not understand that there exists a higher standard for fiduciary advisors.
Second, when it comes to services offered to employer-sponsored retirement plans (a primary focus for the DOL), a principal-agent problem prevents better outcomes. Those making the decisions (e.g., plan sponsors’ human resources executives) are not the ones bearing the full cost of suboptimal choices. Accordingly, brokers structure their offerings to target the incentives of the decision makers—lower upfront cost to the company—while making money in less apparent ways off the participants.
That often leaves participants captive to a limited selection of overpriced (but still ‘suitable’) funds that charge several times what a comparable index fund should cost in the open market. This is classic market failure, potentially costing investors hundreds of thousands in excessive fees over their lifetimes.
Defenders of the ‘suitability’ version of advice must resort to logical sleights of hand to make their case. One particularly egregious example is a recent Wall Street Journal op-ed against the proposal. In response to the argument that automated fiduciaries can serve any investors that would otherwise be deprived of a broker’s conflicted ‘advice’ under the new rules, the authors connect the following dots:
- Human advice can be valuable.
- Commission-compensated brokers are human.
- Therefore, suitability-governed salespeople are preferable to fiduciary advice from an algorithm.
One criticism sometimes leveled at algorithmic advice is that it is not currently equipped to take a holistic view of a person’s entire financial situation, beyond asset allocation and portfolio management. While Betterment’s technology is constantly pushing deeper into more holistic financial planning, we agree that certain clients will always have complex circumstances that require a human advisor (which is why we created Betterment for Advisors).
Those same critics will often concede that portfolio construction is, in fact, ideally suited for automation, and that human advisors will need to demonstrate expertise elsewhere (such as estate planning, complex tax and real estate) to co-exist with automated investing services. In other words, say what you will about algorithms, but asset selection and portfolio management is something they already do better than humans, today.
The brokers working with retirement accounts under the suitability standard are typically not providing complex financial planning services. They may do some training for the firm’s employees, but that can be paid for in a straightforward fee-for-service model, and should be subject to fiduciary rules. Most of them are not providing much in the way of estate planning, tax planning, or the like—401(k)s are already tax-advantaged accounts. They are selling product, one transaction at a time. It would be better if they and we both were subject to the same high fiduciary standards for the advice we give.
We do not blindly support regulatory changes which are certain to have a disruptive impact on the industry. But the opponents of the proposal have an intellectually weak position. And there is so much badly in need of disruption when it comes to helping Americans reach their financial goals.
Everyone is entitled to unconflicted fiduciary advice, and at Betterment, we are hard at work building the next-generation service that is making this possible. We support the DOL’s proposal because we believe it will accelerate this shift toward an unambiguous public good.