Occam’s razor is a principle in problem solving by which you rely on the simplest solution first. The principle relies on the supposition that when multiple variables are introduced to addressing a problem, the more convoluted the path to solution, the more likely the chosen path will be wrong.
President Obama would do well to read up on the work of this Franciscan friar, William of Ockham, who died in 1347. The President is rattling his sword again about regulating financial advice–but only on retirement accounts. He seems unconcerned about advice to investors in regular accounts, which contain the same conflict-of-interest issues and far more money. It’s odd that his proposal only addresses retirement accounts, since IRAs and 401(k)s are generally one-fifth the size of an investor’s “regular” accounts. Unfortunately, he gets the theory of delivery correct, but not the practice. Sort of like his plan last year to tax municipal bond interest earned by the “fat cats”. Great concept, right up to the point where bond-issuing municipalities had to tell him that they are the ones who benefit from tax free interest since they issue debt at lower rates accordingly. Isn’t a president’s cabinet supposed to keep him from looking foolish by telling him how this stuff really works? I sometimes wonder if all he really wants to do is stick his finger in the eye of “the man”.
Mr. Obama’s noble assumption is that if all retirement advice were held to a higher standard of care, then conflicts of interest would be reduced, thus benefiting retirees. I appreciate this position since I’m already a fiduciary in all aspects of my investment advisory business. My firm takes no commissions or soft money from any source; precisely what Mr. Obama wants to mandate. It would seem that his plan would actually benefit me directly. But this will only create bigger problems than it solves. Fee-only advice only makes sense for the big accounts. He seems to assume that a commission makes the advice bad. Not when it’s your only choice. The fact is that the minimum investment required to start a new relationship with a typical fee-only firm such as mine is many multiples of the average IRA balance in America: $81,600. The small IRA market is uneconomic for most pure advisors. Barring the brokers that do serve this market will cause two things to happen: The number of advisors able to serve in the capacity will shrink, and the average cost per participant will rise to account for the trouble and increased risk of fiduciary liability. This means that small retirement accounts might go completely unserved because the math won’t work for fee-only fiduciary advisors in that capacity. In the end, the intended beneficiary of the higher standards on advice will receive no advice at all because the new standard will make such advice scarce; and the resulting “no advice” will be worse than the current problem.
The Occam’s principle would be wise for Mr. Obama to consider. The problem lies not in the availability of higher commission products. It lies in the murky world of brokers being allowed to call themselves advisors to begin with, which confuses clients about what services are being rendered. The commission problem and alignment of interest would be greatly enhanced by requiring IRA clients to sign a simple one-page disclosure document in a single bold typed page that says only this: The brokerage firm employee making recommendations on your retirement account earns commissions on what they recommend. They might also earn kickbacks from the products they sell. Their firm may also earn revenue on your investment in up to a dozen different ways. They provide no warranty, no returns, and your agreement to any purchase puts the risk of what happens squarely on your shoulders. They also often have a more favorable opinion about the products that pay them best, and that money comes from your account. Buyer beware. Sign here______________.
Under this plan, fiduciary advisors would be allowed to call themselves advisors and brokerages would not.
That would do far more to protect the interest of retirees than Mr. Obama getting into the weeds of a business he seemingly knows very little about.