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Changes in Financial-Advisor Compensation
Substantive provisions of the US Department of Labor's (DOL's) Fiduciary Rule—the conflict-of-interest rule—are due to go into effect in April 2017. The conflict-of-interest rule mandates that investors' interests (costs and risk) supersede financial advisors' interests in recommendations about where to place 401(k) and IRA rollover monies. Since June 2016, when the DOL issued the Fiduciary Rule, affected financial institutions have spent millions of dollars in developing appropriate systems and training advisors. Some financial institutions have lobbied against the Fiduciary Rule, worrying that the definition of "fiduciary responsibility" will extend beyond retirement-advice services and affect profits. But for all the money that they spent in preparation, financial institutions have spent much less in an effort to understand how investors feel about the rule or if they are even aware of it.
The long-term trend among households receiving financial advice shows that households that "don't know" how their financial advisor (FA) is compensated have almost doubled between 1998 and 2016; "don't know" peaked in 2012, about when the discussions of the fiduciary ruling began. During the same period, the proportion of households aware that they are paying for advice has increased; the proportion paying no charges to their FAs has declined. (Percentages add to more than 100% because many investors have more than one FA.)
Even though more households than previously realize they're paying for financial advice, increasing focus on the Fiduciary Rule has not quenched their thirst for information. For the trend for information to continue upward, regardless of the implementation of a fiduciary, suitability, or another standard rule—depends on the investor's perception that advice is valuable. If the industry is going to thrive in a world where assets increasingly flow into low-cost index mutual funds, ETFs, and algorithm driven robo advisors, the perceived value of advice has paramount importance. It may make economic sense to segment investors by their assets under management (AUM). However, it does not necessarily follow that any individual investor prefers that type of advisor compensation, frequency of interaction, or channel(s) for communication.
Differences between investor types derive from a comparison of households that use commission-based FAs with households that use FAs compensated by either a flat-fixed-fee arrangement or a percentage of AUM. The two-decade trend reveals that since 1998, the proportion of advised households that pay commission-based FAs has remained static; flat-fixed-fee payments have gradually increased from 16% in 1998 to 24% currently; investors compensating their FAs using a percentage of AUM have increased in number from 8% to 23%.
Investors using different forms of compensation differ along several dimensions, but most important are differences in their financial attitudes: the degree to which they follow their FAs' advice, whether they would follow their FA to a different firm, or whether they would recommend their FA to their colleagues, friends, or family. Investor households' relationships with their FAs should not simply be a matter of investment performance, but also of types of service, intangibles such as the amount and manner in which they prefer to communicate, and recommendations and referrals of a quasi- or nonfinancial nature. Institutions interested in learning how these types of investors differ should contact us for more information.
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