I was talking to my broker the other day about the changes that are coming for individual retirement accounts. The biggest change is that brokers and others who manage or advise people on individual retirement accounts will need to take on a fiduciary duty. This means that they will be required to work in the best interest of the client,rather than their own best interest or the best interest of the firm. Currently, they are required to recommend “suitable” investments, but not necessarily the lowest priced investments.
In many ways this is a good thing since it will help to prevent the common practice of selling things like annuities and proprietary funds that perform poorly relative to other investments but pay the salesman and their firm a big sales commission. Unfortunately, there are many who take advantage of the lack of knowledge of their clients to make money for themselves. We don’t need people with the stereotypical used-car salesmen approach selling financial instruments.
The downside is that there will be a lot more paperwork, particularly if you do have knowledge of what you’re doing and want to go against the conventional wisdom. For example, I see no reason to own bonds at my stage of life (although I do own some REITs) since I have more than 20 years until retirement. I know that stocks will return several percentage points more than bonds over that period and I don’t want to give up that additional return. I take the chance in any given year of seeing 40-50% of my portfolio value evaporate because of this position, but I also feel that stocks will recover from any such drops before I need the money because I have 20 years. As I get closer to retirement, as long as I have at least 2-3 times what I really need to make it through retirement, I’ll probably stay heavily invested in stocks since I’ll be able to take a 50% drop without it really affecting me. I’ll have excess funds, so if I lose some money I can still eat.
The conventional wisdom for someone my age would be to have about 35% invested in bonds by this point. This would help shelter me from market downturns since bonds usually fall less than stocks since the interest they pay helps prop their prices up. The issue with this strategy is that it doesn’t take the effect of time in reducing risk into account. It uses diversification – spreading out investments into more than one type of asset – to reduce risk, but holding the investments for a couple of decades also reduces the risk. Having 35% of my portfolio invested in bonds would mean that I would get about a 6-8% return on that money instead of the 12-15% I can get in stocks over the same period of time. That can add up to be a lot of money. The new laws, however, will certainly require me to sign a lot of documents saying that I understand the risks of doing so. Perhaps in the future I won’t even have the choice.
The reason these laws were enacted, however, was that most people aren’t financially literate (and generally proud of it, for some reason), and the people taking care of their money for them were lining their own pockets. Generally, this was not by offering them investments that were too risky, but investments that we’re risky enough, such that they lost a lot of the return they would have gotten if they had invested properly, but have high fees. These are things like annuities, which almost no one under age 65 or maybe 70 should have.
So in summary, because most people don’t even get the preliminary education in investing and money management that they could get through reading a couple of books (The SmallIvy Book of Investing, Book 1 on sale now!) or reading blogs like this one, they need to rely on “experts.” Many of these “experts” have little financial education other than on how to sell the high-fee annuities and funds their firm is pushing. Because of this, we’re going to see a lot more controls on the people who manage money and sell financial instruments. Unfortunately, people are ignorant enough about finances and some advisors are unscrupulous enough that this is needed. I’m just hoping that the rest of us who do know what we’re doing will be able to still make the choices we feel are right for our situation.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.