When you walk into a brokerage firm or a bank and ask to meet with one of their investment managers or brokers, you expect they are licensed, experienced, and trustworthy, right? If they claim to be a fiduciary, you also expect them to actually be a fiduciary, right? After all, they have a big, brand name on the outside of their building.
Well, caveat emptor, let the buyer beware.
What you may not realize is that bankers and brokers may hold dual licenses, and there are no rules or regulations against it. For instance, a broker can have both a Series 67 and a Series 66 license or a Series 7 and a Series 65 license. (Okay, no one outside of the financial services industry really understands what I’m saying, but stay with me here.)
When it comes to securities, dual-licensing means the financial services professional can be both a licensed broker (a salesperson collecting commissions) and a licensed fiduciary (a financial advisor supposedly looking out for your best interests).
Seems tricky, right? Sounds like a big conflict of interest, doesn’t it? Well, yes it is.
Dual-licensed professionals are required to read a “dual-hat disclosure,” or something similar, to potential clients. The disclosure essentially states, “When I am speaking to you about your financial planning, I’m speaking to you as a fiduciary, but when I am recommending or offering any products for sale, I am speaking to you as a broker.” It’s kind of like a doctor giving medical advice, then switching to a pharmaceutical rep moments later and prescribing the company’s latest, most expensive brand-name drug—the one that pays him the highest commission.
This is a conflict of interest. Worst of all, this situation isn’t uncommon. Most people just don’t know about it.
Brokers Are Salespeople
You can’t be mad at a salesperson for selling you a product. That’s their job. If you walk into an auto dealership, you can’t be upset if they sell you a car; that’s what they’re paid to do. It’s your problem if you let them talk you into buying a car that’s not a good deal. It’s your financial responsibility to make the payments and make sure you didn’t pay too much.
If you’re letting yourself take financial advice—especially retirement planning advice—from a salesman who’s also a “fiduciary,” that’s your fault. You are shooting yourself in the foot, because brokers won’t sell you something that they don’t make commission on. That whole “I’m a fiduciary” thing here to give you the best advice (but only half the time) just isn’t true. Their sales career will be in jeopardy if they don’t sell what their firm is requiring them to sell.
Brokers will put you in a pie chart containing stock and bond funds, even if this really isn’t in your best interest. They have the legal protection to do that, and they can’t be sued. Why? Because of the risk assessment test.
The Risk Assessment Quiz
Brokers have you fill out a “risk questionnaire,” which is typically comprised of about ten different questions. Based off your answers to these questions, your pie chart is created. If your pie chart does not perform well, and you end up losing money, you cannot turn around and sue that brokerage firm because, technically, you’re the one that created the pie chart—not them. You created it based off of the answers to your questionnaire. Even though they’re the expert, you technically put it together.
The Big Chunk Of The Pie Chart Called “Bonds”
Now that you know that you are the one responsible for creating your pie chart, let’s talk about the pie chart for a minute. For the most part, your pie chart contains two things: stocks and bonds. The biggest part of your pie chart is usually in stocks when you’re young (not individual stocks, but mutual funds containing stocks).
The pie chart is based on a “buy-and-hold” accumulation strategy that may work when you’re in your 20s, 30s, or 40s. But, once you start getting closer to retirement, it definitely doesn’t work. You simply don’t have the time horizon to get your money back from a market crash, which typically happens every seven to eight years, or interest rate fluctuations for that matter.
Here’s why: The retirement “Rule of 100” used by brokers says that you should start moving more money over into bonds based on your age because they are “safe.” So, at age 55, you will hold 55% of your pie chart in “bonds,” and at age 75, you will hold 75% in bonds, increasing every year. The trouble is, “bonds” are considered to be synonymous with “bond funds,” but they’re not. Bond funds should not be considered safe money.
The Difference Between Bonds And Bond Funds
What’s the difference between a bond and a bond fund? A simple, individual bond can usually be considered safe. It’s fixed, for the most part, and it will pay a certain percentage amount of return on top of your return of principal at maturity, say after 10 years, or whatever the duration is.
Bond funds are unique. A bond fund is a type of mutual fund that’s full of hundreds of different types of bonds with different maturities from all over the place. One of the advantages to a bond fund is that it’s liquid. You can get in and out of it at any time. But, one of the huge disadvantages is that the net asset value of that bond fund is dependent upon all the face values of the hundreds of different bonds that are within the fund.
As interest rates rise, the value of the bonds in the bond fund will go down, because nobody wants to buy a bond that’s paying 2% today if next year’s bonds are paying 4%. Demand will fall, and the face value will fall, and then the net asset value of the bond fund is going to fall with the face value of all these individual bonds. You can look back historically and see that this is true. For instance, in 1994, interest rates went from 6% to 8%, and the average bond fund fell by 20% that year, per Morningstar.
With interest rates being at historic lows and the Fed saying they are going to raise them, it doesn’t make sense to have the majority of your assets in bond funds as you approach retirement.
When Smaller Might Be Better
Art Levitt, past SEC (Securities and Exchange Commission) chairman, said that if you have more than $50,000 of investable assets, you should work with an investment advisor, who is a fiduciary.
There are a few, albeit very few, real fiduciaries out there. In fact, there are approximately 1.6% who are singly-licensed true fiduciaries, according to Tony Robbins’ research. From his website, “Of the 10% of financial advisors who are fiduciaries, many are dually registered — meaning they can act as both a broker and a fiduciary. Legally, they don’t even need to notify you of their dual status, or whether they’re acting as a fiduciary or a broker at any given time!”
So what are the requirements of a true fiduciary? All three of these things must be present:
- A true fiduciary holds only one license – the Series 65. There are no conflicts of interest, and they are legally required to provide advice in your best interest—even if they don’t make any money on it.
- Their firm must be set up as a Registered Investment Advisory (RIA), completely independent of any big brand or company that develops and sells investment products. There’s no one telling them what to sell or recommend; they have access to hundreds of products from various financial entities.
- Their firm is independent, fee-based, and transparent. You’ll know about the fees you’re paying, whether they’re charging a 1% fee, a 2% fee, or a flat fee for the year—whatever it is, or however they set it up is fully disclosed—that’s how they’re getting paid. There are no hidden commissions or different ways that they’re making money that might change their advice.
You owe it to yourself to make sure you don’t hire a financial specialist who talks out of both sides of their mouth. Find a single-licensed, true fiduciary.
