This is the basis, but how do you measure the differences?

It’s done by measuring the equity risk premium.  This measures the long-term market relationship between the historical expected return difference between stocks and bonds.  This difference is one measure that helps determine the stock-bond asset allocation in the portfolio.

The equity risk premium is the difference between the long-term expected returns between stocks and bonds.  It is a crucial assumption used by investors–such as pension and endowment funds, foundations, and individual investors, including 401(k) participants and very high net-worth individuals – when deciding how much to invest in stocks and bonds to meet them to meet future needs.

The traditional equity risk premium has been 4% in the past. This premium was in line with post-war capital market history and within the range shown as reasonable in academic studies. The recommendation to use a 3% risk premium relied on further research into the long-run behavior of corporate earnings growth, dividend yields, and intermediate Treasury bond returns.

This measure forecasts future returns for large portfolios, such as pension funds.  However, when the premium is reduced, investors will have to take more risk for the same return in the future, or they will have to expect decreasing returns.

What This Means?

While seemingly esoteric, the change in calculating the equity risk premium has broad implications. Take a portfolio that is 60% equities and 40% debt. A 1% reduction translates into a 60 basis point, or 0.6%, reduction in expected return.

While a 0. 6% reduction in an investor’s expected return on an investment may not seem exciting, it has significant ramifications over the long term.

The reduction in expected returns affects corporate pension plans’ accounting for their plan. The 1% equity premium reduction implies the fund should reduce its expected long-term return on assets (ELTRA). A formal reduction in the ELTRA would raise pension expenses immediately.

If a fund does not change its assumption and returns are consistently less than expected, it can expect an increased frequency of amortized losses in the future.  For individuals who accept the idea of a lower future expected return, investment theory indicates that when investors think an asset will not return what it has in the past, that asset becomes less attractive.

When this occurs, investors can develop a higher appetite for other investment opportunities that offer higher returns, such as hedge funds, private equity, and real estate.  While these investments provide higher expected returns at higher risk levels, their relative attractiveness to lower-returning assets, such as stocks, becomes stronger as the equity premium is reduced.

Does this mean US investors are increasingly willing to hold more risky assets, such as stocks, as opposed to a few generations ago, when bonds were more common?  What would account for this change?

Modern capital markets better have increased ways to diversify risk, such as investing in low-cost mutual funds, so investors can collectively take more equity risk.  Since retail investors have become more invested in equities of all types, individual stocks, mutual funds, and ETFs, they have increased overall equity valuations.  This has worked to reduce the required return for holding equities based on traditional stock-bond relationships.

Risk is an inherent part of any investment.

Since there is always the possibility an investment will decline in value, investors must identify the risks that can degrade returns and then develop a plan to minimize the effects of risk on their overall portfolio.

The key to controlling risk and portfolio volatility is asset allocation.

Asset allocation is a critical investment decision that can help you become wealthy but also help you keep your money by reducing risk.  Based on your time frame, needs, and risk tolerance, portfolio allocations are made by dividing your money between assets, such as stocks, bonds, commodities, and real estate.

This allocation process is critically important because one expert predicted that no matter what investment you pick, during your lifetime, any investment will fall in price by 50% to 70%.  For instance, in two recessions in the 1990s, each downturn caused a 50% stock market decline.

Risk, or the variability of achieving a specific investment return, relies on various factors, such as those related to one particular investment and the overall economy.

Economic risk comes from such factors as news about inflation, industrial production, Fed monetary policy, employment, consumer sentiment, and international events.

All of these factors influence the stock and bond markets in different ways.  By diversifying across asset classes, you can reduce investment risks affecting the variability of returns.  Investors who diversify but limit themselves to a single type of asset class, such as small-cap stocks, assume more risk than those who invest across different asset classes.  It’s also important to note that cryptocurrencies are not an asset class and have no functional role in diversification.

Since behavioral finance has found that most people fear losses more than gains, investors should divide their investments into more secure ones or potentially deliver more significant growth accompanied by higher risk.  This includes stocks and bonds but, surprisingly, not real estate.  That’s because home prices (adjusted for inflation) have not increased for about 100 years, except in market bubbles.  The caveat is that homes deliver tax advantages and, potentially, rental income.

Modern Portfolio Theory and Risk

Risk management today has its origins in Modern Portfolio Theory (MPT).  This Theory traces its roots to a paper written in 1952 by Harry Markowitz, who used statistical techniques to describe the efficient frontier concept.  It is considered so important that the paper earned him the Nobel Prize in Economics nearly four decades later.

In his short paper, as well as in other works, Markowitz proposed that the overall risk in any investment portfolio can be identified and managed by examining the risk relationships between combinations of investments.  The risk could be spread, or diversified by looking at these relationships throughout the portfolio.

In short, he proved that rather than looking at the risk of each asset, he showed that a diversified portfolio is less volatile than the total sum of its parts.  The entire portfolio’s volatility can be low, even though each asset might be pretty volatile and riskier.

This was a landmark concept.  By the early 1960s, Markowitz’s ideas were largely credited as the basis for MPT.  An essential part of this Theory is that risk can be managed through diversification and that a better risk-adjusted performing portfolio can be built using combinations of different assets.

One landmark study by Roger Ibbotson and Rex Sinquefield found that asset allocation policy is so vital that it determines more than 90% of a portfolio’s performance variability over time. (Copies of these important academic investment papers are contained in the book, The Handbook of Corporate Earnings Analysis.)  

Implementing a Diversification Plan

Portfolio diversification is achieved in numerous ways:

• Within an asset class, such as bonds (that include long-term, medium-term, government, municipal, and junk) and stocks (that include internal, large, small, and medium cap, dividend-paying, and international), and
• Between asset classes, such as a portfolio comprised of bonds, equities, ETFs, options, real estate, and precious metals, and;
• By using different strategies or exposures involving mutual funds and ETFs.

Identifying Risk

Thanks to MPT, several different ETFs and mutual funds today can deliver a diversified portfolio of investments, usually within a single asset class in a single fund and in a single purchase.

While Markowitz’s idea of MPT is over 50 years old, his Theory of linking risk to return has helped create an entire industry devoted to risk management.  For investors, this has made it possible to quantify a portfolio’s risk level, so investors should expect to get a higher return if they assume more risk.  That simple idea has re-shaped investing.

Asset allocation should be considered a risk-growth proposition.  This is because no asset class appreciates continuously, and since markets run in cycles, it’s possible to lose all gains without adjusting the portfolio.

Asset allocation is done by investing in the seven main asset classes–stocks (including ETFs), high-yield bonds, real estate, commodities, currencies, collectibles, and structured notes–across markets and in different time frames.  Many experts, such as John Bogle, the founder of Vanguard Funds, said the easiest way to get diversification is by investing in low-cost index funds, which provide a tax advantage and broad equity exposure.  That same strategy can be used via ETFs.

Building a Portfolio That Mirrors Your Risk Level

Each investor has to know their risk level before considering what type of portfolio to own or build.  The basic rule of thumb is that risk levels depend on age and comfort level.  Younger investors can take more risks because they will live longer and have more time in the market.  If younger people suffer a loss, they will have more time to recoup the decline.

Older investors do not have the luxury of time, plus they may be soon exiting out of the workforce.  This means they must preserve their investment principal since any losses will take longer to recover.  Time is not on the side of older investors in this situation.

So, with that in mind, here are some basic outlines of different risk-level portfolios for investors to consider.

What is a Conservative Portfolio?

The purpose of a conservative portfolio is to preserve capital and minimize the risk of loss.  In this example, portfolios are over-weighted with fixed-income instruments (including tax-free bonds) and money market funds, supplemented by large-cap stocks.  Conservative portfolios do not suffer the same price fluctuations as portfolios with riskier assets.  Investors with a short-term time horizon who want to preserve capital, are retired, or are approaching retirement often choose conservative portfolios.

What Is a Moderately Conservative Portfolio?

This portfolio is designed to generate income through dividends and bond coupon payments while preserving capital.  It can also include Treasury Insured Protection Notes (TIPs) that provide inflation protection.

What Is a Moderately Aggressive Portfolio?

Also known as a “balanced portfolio” with a near-equal mix of stocks and bonds, this portfolio is commonly known as the 60%-40% portfolio and has a mix between growth stocks and income-producing bonds and cash.  It is best suited for investors with moderate risk tolerance and a longer (more significant than five-year) time horizon.

What Is an Aggressive Portfolio?

To achieve more significant growth and capital appreciation, this portfolio has greater exposure to equities, especially small-cap and international equities with higher risk exposures.  This portfolio is better suited to younger investors early in their careers and can withstand any short-term losses that can be rebuilt over time.

What Is a Very Aggressive Portfolio?

This portfolio is for investors with the most prolonged time before retirement and more incredible risk appetites.  It includes the highest percentage of equities and more volatile instruments, such as leveraged instruments, and exposure to more exotic asset classes via ETFs with exposure to emerging markets, small-cap stocks, and international bonds.  The goal here is to generate the highest possible capital appreciation over time.  It is best suited for people with solid risk tolerances who can accept the risk of losing some of their money.

Managing Risk in a Fixed Income Portfolio

Fixed-income portions of portfolios are subject to different market situations which affect prices.  In a rising interest rate environment, investors in bond funds of all maturities will see their principal decrease while their yields remain at their current low historical levels.  For instance, 30-year bonds may yield about 4.3%, but investors have to assume more risk to get that yield.  If investors want bond yields in the 6% to 7% range, bondholders should shorten their maturities to three months.

While bonds are less volatile than stocks, the push into bonds is not risk-free.  In the past, fixed-income investors should recognize that a bond fund’s total return is attributable to capital appreciation and yield.  But today, yields on the 30-year bond range are around 4%.  This has made capital appreciation the main engine for propelling bond funds higher in price.

However, betting on appreciation carries risks related to capital losses versus the current yield.  Individual investors often pursue under-valued assets, or higher-risk assets, such as high-yield bond funds, to generate income.  However, the problem is that bond funds sell bonds as they reach maturity and replace them with similar bonds that will mature later.  The better choice is for investors to buy individual bonds, not bond funds, and hold them to maturity when they return their face dollar amount.

However, since many individual investors do not buy individual bonds, they should diversify across the fixed-income investment category to include high-yield, corporate, municipal, and international bond funds.  This type of exposure is available in mutual funds (Franklin Total Return Fund and the JP Morgan Income Fund) and ETFs (Vanguard Total Bond Market ETF (BND) and the Invesco Total Return Bond ETF).

The US Supreme Court ruled on Jan. 24, 2022, that investors can sue employers and managers if they charge excessive mutual fund management fees.

In the 8-0 decision in the case, Hughes v. Northwestern University, the conservative-leaning Supreme Court found that “401(k) plan participants could continue to take legal action against employers for including high-fee, high-risk investments in their 401(k) lineup, even if they also included lower-fee, lower-risk options,” according to a story by Mathew Cunningham-Cook in The Daily Poster.

The ruling applies to 401(k) plans, but not pension plans. The ruling again points out the importance of investment fees and expenses embedded in 401(k) plans that are often not fully disclosed to participants. As noted for years, some pro-investor professionals have said that fees are critical in determining an average 401(k) participant’s net portfolio return.

The article said that the median 401(k) balance for Americans 65 and older is only $64,548, however, amount could be as much as 40% higher, if it wasn’t for fees paid to Wall Street investment managers and 401(k) administrators.

Mutual Fund Fees Are Critical

As noted in my book, How 401(k) Fees Destroy Wealth and What Investors Can Do To Protect Themselves, 401(k) participants pay over $164 million in fees on a daily basis to the financial services industry. These fees, plus an old arrangement called revenue sharing between employers and investment firms, cost investors over $10 billion annually. (See the press release here.)

All of these fees come at the expense of individual 401(k) participants, and they all ultimately affect the dollar amount in their individual retirement accounts.  Worse, many employers don’t police these numerous fees, so they violate the fiduciary role that exists between employers and their workers to protect these financial assets.

Studies have shown that high fees can reduce the value of a $100,000 401(k) portfolio by as much as $30,000 over 20 years.

Some Financial Industry Groups Oppose Lower Fees

As they have done historically, an array of investment management lobbying groups and managers filed briefs in support of the defendant, Northwestern University. These groups included the Committee on Investment of Employee Benefit Assets; the American Benefits Council; TIAA-CREF, a major manager of 401(k) plans; and, the Investment Company Institute, the mutual fund company trade association whose members profit from 401(k) fees.

As they have in the past, many investment industry lobbying groups openly oppose regulations that would favor individual investors.

In the Supreme Court decision, Judge Sonya Sotomayor wrote that “in Tibble, this Court interpreted ERISA’s duty of prudence in light of the common law of trusts and determined that ‘a fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.’”  The keywords here are “continuing duty” and “removing imprudent (more expensive) ones.”

Commenting on the rare-pro-investor ruling, Chris Tobe, a financial analyst who works with lawyers seeking accountability from 401(k) plans, said the Supreme Court’s 8-0 decision “shows that even conservative people in 401(k) plans don’t think that they should pay excessive fees.”

How Investors Can Protect Themselves

Individual investors can protect their investment portfolio by doing the following:

• Invest only in the lowest cost mutual funds and exchange-traded funds (ETFs). If a fund has a lower cost but is not have the highest return over time, pick the lower-cost fund. Lower fees over time convert into a higher net return.
• Buy funds from low-cost managers, such as Vanguard.  Vanguard is a co-op company, so it passes along lower costs to its investors.
• Chose managers that follow the fiduciary standard.  Many companies violate the fiduciary standard when it comes to disclosing executive salaries, as well as for investment firms that work to bury fees and make them as opaque as possible.
• Buy ETFs that have lower fees, but provide the same or better investment sector coverage than mutual funds.
• If you see that your employer is not offering lower-cost mutual funds in your 401(k) plan, contact the company’s HR Department. If they don’t act, contact a securities lawyer.
• To see how employers work against the interests of their own employees in their 401(k) retirement accounts, see this video from PBS. 

It is widely recognized in the modern world that the earth revolves around the sun.

Now, it is time for more investors to understand that the fees charged to manage your mutual funds in a 401(k) and elsewhere all reduce your net investment returns. There is a direct connection: the more you pay in fees to investment companies, financial advisors and 401(k) administrators, the less money you will have in your own account.

While managing money requires expertise, there is a balance between what fees you are paying for this expert service and what you get in return. All-in fees (including 12b-1 and the other 18 or so possible fund fees designated by the U.S. Department of Labor and SEC) in the 1.3% to 1.5% fees considered in the average range for mutual funds are acceptable, provided your returns exceed an established benchmark, such as the S&P 500 or MSCI EAFE Index. Expert advisors and companies deserve to be compensated for their talents.

The problem is when uninformed investors pay fees that benefit investment professionals and firm more rather than you, the investor. Surprisingly, many 401(k) participants think they are not paying any fees in the 401(k) plan. This is a big mistake. It is one that costs investors hundreds of thousands of dollars over an investing lifetime.

New Study Shows the “Destructive Impact” of Fees

In a study conducted by Craig Israelsen in the July 2017 issue of Financial Planning, Israelsen analyzed the impact of a hypothetical $1 million portfolio over 23 rolling periods of 25 years each in a portfolio compared to seven standard indexes to gauge the impact of fees. Fees were comprised of fund expenses and manager fees.  He also accounted for required minimum distributions for people with IRAs over age 70 ½.

Using different scenarios of total fund fees ranging from 50 basis points (bps) and average annual withdrawals over the 25-year-period, he found the following changes in account balances in a portfolio starting out with $1 million:

• If you are paying total portfolio fees of 1% (100 basis points), over 25 years, you will have an average account balance of $2,428,629, and will be able to withdraw $146,853 per year over the 25 years. This gives you an average total amount to withdrawal over each 25 year period of $3,671,335.
• If you paid 2% in fees (200 basis points) over this same period, your average account balance would be $1,905,338 and you could withdraw an average of $126,426 annually during each 25 year period.
• If you want to pay even more in fees, say 3% (300 basis points), your average ending account balance over 25 years drops to $1,491,240 and you only get to withdraw $109,104 annually for a total of $2,727,594 in withdrawals over the 25 years.

This is a lot to digest, but Israelsen said the impact of fees is “huge.”  He also says: “

Think of it this way: if a portfolio had a total cost of 100 bps and by using lower-cost products or reducing the advisory fee the total portfolio cost could be halved to 50 bps, the retiree could withdraw $11,554 more from the portfolio each year and her ending account balance would be higher by roughly $288,850 after 25 years.”

These are powerful calculations that can make a big difference to your quality of life in retirement.

Impact of Fund Fees Over Time (Source: SEC)

Fees vs. Privatized Social Security

But fees also play a huge role in the political battle over the future of Social Security.

Republicans have already announced plans to privatize all or part of Social Security using the cover story that government has no role in private lives. But the bigger reason is that investment companies, which rank among the largest lobbing forces in Washington, have been engaged in pushing for privatization of the multi-trillions in Social Security for decades. And the goal of privatization is, you guessed it, the huge potential revenues generated by charging fees.

Fees also play a huge role in generating revenues for banks, credit card and student loan companies. Nor are excessive fees just restricted to individuals. The numbers are even worse for unsuspecting or poorly managed institutions. The North Carolina state teachers’ pension fund in 2014 invested in about 300 hedge funds. The net result was that the fund saw that “fees have skyrocketed over 1,000% since 2000 and have almost doubled since (2008) from $217 million to $416 million,” former SEC investigator Ted Siedle wrote, adding that “annual fees and expenses will amount to approximately $1 billion in the near future.”

It was no surprise that the North Carolina fund underperformed the average public plan by $6.8 billion, according to Siedle.

This large public fund (at the time the nation’s seventh largest public fund) was managed and overseen by a team of highly-paid managers and consultants, and they still made serious mistakes.  Unsuspecting individual investors make these same mistakes every day.

So Here is the Bottom Line

When you buy a mutual fund you pay fees.

When you pay fees, you often pay for many services that do not boost your investment returns.

When you pay for services you don’t need, you pay for people who don’t help you make more money.

When you don’t make more money, you can’t retire.

When you can’t retire, you end up working longer and eating dog food.

So learn about the mutual fund fees you are paying.

Learn how to save more retirement money by paying less in fees.

Learn more by buying this book:

“How 401(k) Fees Destroy Wealth and What Investors Can Do To Protect Themselves”

The Republicans have never hid their distain for regulation and now with the surprise victory of Donald Trump and his arch conservative vice president, the simmering Republican distain for reversing all things from the 1930’s New Deal will are going to be reviewed and partially reversed . This will take time, but the anti-investor, Republican, neo-conservative, anti-federal, free-market political impetus is now a reality.

This also means that any professional financial advisor who does not acknowledge this new reality into their daily practices will show their more astute clients that they are seriously out of touch with reality.

This means pre-retirement financial preparations have to include potential changes to Medicare and Medicaid, including the sad fact that many Medicare recipients will now be forced to pay bills from their hospitals that Medicare previously covered. This will mean a return to medical-related bankruptcies for millions of retirees.

The phobic response to the Affordable Care Act will also mean higher health care costs, or none at all, for millions of Americans. Again, this could take years to repeal, but the sword is hanging over the heads of millions of people approaching retirement and will cut into retirement savings in the event of a serious illness or health issue.

Then, we have the now ancient Republican attacks against regulation, pushes for privatizing Social Security and the imposition of high fees and expenses on unsuspecting investors.  This also include repeal or curtailment of the breakthrough U.S. Department of Labor’s (DOL) fiduciary standard which was designed to give average investors an even break by having well-trained, and often unethical retirement professionals, revealing which funds would be the cheapest for their portfolios.

Even after a decade of debate on the fiduciary standard issue and its importance to uninformed plan participants, “plan sponsors, as a whole, are unaware that participants pay disparate fees, and service providers, particularly recordkeepers that receive revenue-sharing payments, are not going to address it, experts say,” according to an article in Plan Sponsor by reporter Lee Barney.

Yet, while the Republicans make a concerted effort to repeal the fiduciary standard under the guidance of their well-paid professional lobbyists, ERISA law expert Fred Reish said “while there are no requirements to charge equitable fees, in Field Assistance Bulletin (FAB) 2003-03, the DOL indicated that allocating plan expenses is a fiduciary decision that requires fiduciaries to act prudently,” Reish, of Drinker Biddle & Reath, said in the same Plan Sponsor article cited earlier. “Whatever allocation method is used, the failure by fiduciaries to engage in a prudent process to consider an equitable method of allocation of plan costs and revenue sharing would be imprudent and a breach of fiduciary duty.”

Fund Fees Are Still Critical

Similarly, a white paper, “Deciding what is Reasonable: Assessing Fees Using Value and Outcomes,” from TIAA-CREF reiterated that reviewing how fees are charged to participants is a best practice sponsors need to consider.

Charging excessive fees and expensive, revenue sharing, and employing expensive, national wholesaler selling networks to sell commodity-type mutual funds to retirees from an employer’s meeting rooms is an insult to employees and a violation of the employer’s duty to do what is in the best interests of their employees while they are in the workplace.

The problem with selling inappropriate, expensive mutual funds and other retirement-related investments from the workplace human resources facilities not only hurts current working employees, but it could send them on a misguided path for decades after they enter retirement at  the same time when their earning capacity approaches zero.

As for Millennials and younger people who are still facing decades of working, a new study from Oxford University finds that 47% of current jobs will not exist in just 25 years. This means more job dislocations, the need for more schooling and re-education for find jobs that offer comparable salaries and benefits in an increasingly automated age.

Those Trump supporters who want the old factory jobs back that they lost years ago must have suffered from a frozen memory because if those jobs ever came back, they would be almost completely automated, and need fewer, more highly-trained workers. It would not be “happy days are here again” since automation guarantees faster obsolescence and more job disruptions. All this spells huge gaps in the ability to save for retirement, compounded by greater out-of-pocket expenses for medical bills, tuition and potential cuts in Social Security.

So while it’s understandable that financial professionals don’t discuss politics and bad news, they look very foolish if they meet with a client in 2017 and pretend they don’t know what’s looming on the horizon. Despite all the old, tired talk about the benefits of diversification, hot new funds, risk management, the benefits of expensive annuities, and saving more, an honest, pro-client retirement planning professional will have to publicly admit that the retirement planning future has never looked this bleak.

This biblical phrase, “Do to others as you would have them do to you.” (Luke 6:31) has driven discussions about the ethics of reciprocity for over a thousand years, but at many of the nation’s largest financial services firms, this lesson is unknown in everyday business practices.

But this may be changing thanks to a new government regulation that will call for more complete disclosure by financial product salespeople about how they are being compensated from their firms for selling a specific investment product to less sophisticated clients.

The new Department of Labor (DOL) rule, known in the industry as the fiduciary standard, is in the final stages and was sent to the White House for review, according to the Office of Budget and Management. The rule was shepherded through an arduous, years-long approval process by Phyllis C. Borzi of the DOL.

After a decade of contentious debate, intentional stalling by the financial industry, attempts to get the SEC to issue less stringent rules, and heavy anti-regulation lobbying, the DOL and the White House are moving to get the proposal enacted, so it can be signed by President Obama before he leaves office. Even then, Republicans, who generally oppose regulations, will seek to overturn the rule if they get the chance, along with Obama’s other key program, the Affordable Care Act and the new Consumer Protection Financial Bureau.

Yet despite this contentious opposition from some investment companies, the average investor has probably never heard of this issue. That is because the mainstream financial media–Bloomberg, CNBC, Fox–don’t discuss an issue which is essentially giving average investors more control over what they buy. In essence, the DOL’s fiduciary rule proposal presents a fundamental change in the power structure in favor of average investors who now have monetary recourse to recoup losses resulting from advice tainted by conflicts-of-interest.

Decades ago, the financial industry fought to make arbitration, rather than the courts, as the venue where losses from bad advice were adjudicated.  Arbitration was chosen since it would grossly favor the financial industry in these disputes.  The fiduciary standard essentially reverses some of the industry’s power by making it more accountable based on the new higher, pro-investor fiduciary standards.  While it looks like a simple change to the average investor, it is one that will fundamentally change the brokerage selling business model. And if there is anything the financial services industry hates, it is change, especially when it gives investors more power.

Not the Best Time for Honesty

The proposed fiduciary standard is coming at a bad time for the financial services industry. Recent market volatility accompanied by falling indexes, has cut profits at wealth management firms. The fiduciary standard will force salespeople to disclose their conflicts-of-interests and may also cut into commission profits at major firms where selling more expensive, less suitable products has contributed to profits for decades.

As a precursor to how honestly dealing with the public will changes some aspects of the financial services industry, Ameriprise CEO Jim Cracchiolo said in a Financial Planning magazine interview, “We expect to have to make some adjustments in the commission-based business.” Ameriprise will be able to work with either a fee- or commission-based business, Cracchiolo said. In a separate story, Financial Planning quoted Paul Reilly, the CEO of Raymond James, which has 2,600 office nationwide, that while the DOL rule  is “well intended, it is not good for clients.”

The prevailing industry complaint is that giving investors honest advice will cost investors more never gets seriously challenged by the financial press.  A closer look shows that it will cost brokers more in lost sales than it has in the past, when they sold more expensive products.  How this translates into higher costs for customers (as the industry continues to repeat) could only happen if the brokerage firm sought to replace that lost revenue by charging clients more in fees and by raising other expenses.

Now, why this would happen is confusing to unsuspecting investors, but the industry has phrased their opposition to the fiduciary rule this way since it would impact their corporate profits, not the portfolio profits of naïve investors.

That’s because 401(l) investors alone pay $164 million in fees daily to the financial services industry, plus the new rule will change revenue sharing and 12b-1 fees that cost investors another $9.5 billion annually, as shown in the book, How 401(k) Fees Destroy Wealth.  Plus, many brokers will have to explain their rationale when suggesting new investment options to clients, which could force them to sell better-suited, less expensive products to clients.

In short, what the financial services and wealth management industries will be forced to do is increase the bottom-line net returns to their clients because client fees can be reduced as a result of lower fees and expenses. Lower fees directly translate into higher net returns for clients.  These potential higher returns come at a time of exceptional market volatility and unpredictable market returns. Yet, as many academics have proven including John Bogle of Vanguard, fees and expenses are the two variables investors can directly control that increase their returns without additional risk.

But some firms that want to avoid increased customer transparency are exiting the business.  AIG, one of Wall Street’s shadiest operations, said it would sell its broker-dealer operation. AIG CEO Peter Hancock said the new fiduciary rules would increase the firm’s compliance costs (a standard industry excuse). But AIG would certainly want to avoid disclosure based on its history.

In March 2009, Think Progress reported that the government was going to intervene for a fourth time to help A.I.G. avoid bankruptcy. “The government already owns nearly 80 percent of the insurer’s holding company as a result of the earlier interventions, which included a $60 billion loan, a $40 billion purchase of preferred shares and $50 billion to soak up the company’s toxic assets,” the report said. These federal rescue operations were certainly not the result of the company’s transparent operations.

So how much will honesty hurt the financial services and wealth management businesses? A Bloomberg news report quoted an analyst at FBR Capital Markets, who said the new rule would have a “chilling effect on sales and commissions.” “Chilling” is analyst-speak for fewer commissions because more expensive, and often less appropriate investment products, won’t be able to be sold unless the broker makes the case why they are better than a less expensive alternative.

This could also mean lower broker incomes. One Merrill Lynch district manager said he was moving to a higher-level supervisory role as a result of the new rule since his commissions would be cut. Certainly, more high-commission firms are thinking of exiting the business rather than giving their customers an even break.

This could also mean that mutual fund wholesalers, and their internal support staffs, could be reduced, especially if revenue sharing and 12b-1 fees are scrutinized.

This army of expensive fund wholesalers brings in new fund sales, but do not add one penny in net returns to investors.

Of course, there are thousands of financial professionals who already have adopted the fiduciary standard in their daily practices. These Registered Investment Advisors (RIAs) are fee-based and have advocated for the rule.  They should now use it as a major marketing edge to show how they are more transparent and conflict-free than the competition.

All of these changes that are just beginning to occur as a result of the fiduciary rule may usher in a new period of what the economist Joseph Schumpeter called “creative destruction” This process happens when outmoded jobs are eliminated. Schumpeter also said this process is an essential part of capitalism, so it should be no surprise that the financial services industry is now facing one of its own creations. Ironically, all of this is happening simply as a result of implementing the Golden Rule.

frog, who was sitting on a nearby rock, if he could ferry him across the river on his back.

“I would do that for you, but how do I know you will not sting me and that I would not die?”

Perplexed, the scorpion replied: “I would not sting you since you are doing me a favor. And if I stung you, I would also drown in the middle of the river. I also consider you my friend, so I would not harm you for doing me this great favor.”

Convinced by this logic and sincerity, the frog agrees. The scorpion climbs on the frog’s back and they start across the raging river. As they approach the far bank, the scorpion lifts his long tail and stings the frog. As the frog gasps for air, he asks the scorpion why he killed him, despite all of his assurances that all would be well.

The scorpion looks the frog in the eyes and says: “It is my nature and nothing I do can change it.”

Like the scorpion, the nation’s largest investment and trading banks have it in their nature to be repeat offenders of U.S. securities regulation. Despite the fines imposed by the SEC, the same globally-known names keep getting cited by regulators for many of the same offenses.

It is a given that these banks operate with the most highly-paid and educated talent available in their compliance departments. They know the securities laws and regulations and have the best available trade tracking technology and millions in their compliance budgets.

So why does this happen? Why would a global investment bank continue to repeat the same mistakes and risk their public reputation to run afoul of federal regulators?

The reason is that violating securities laws is good business.  And like the scorpion, abusing unsuspecting and less sophisticated customers, their own employees, board of directors and shareholders is profitable and penalty free at the individual level for the perpetrators of securities frauds inside of global banks.

Take the latest case against JP Morgan Chase, the nation’s largest bank with $1.7 trillion in assets (as of December 31, 2014). The firm was cited in the Bloomberg report about how it settled SEC allegations that it didn’t  inform clients about numerous conflicts-of-interest about how it managed customers’ money over a half decade. The SEC fined JP Morgan a mere $300 million, a sum that accounts for a little more than 1% of the company’s annual operating profits, or about a month of profits generated from its asset-management division, Bloomberg said.

The core of the charges was conflicts-of-interest in the information Morgan provided its unsuspecting institutional and retail clients.

In its charges, according to the Bloomberg news report, “firms have an obligation to communicate all conflicts so a client can fairly judge the investment advice they are receiving,” Andrew J. Ceresney, director of the SEC Enforcement Division, said in a statement. “These JPMorgan subsidiaries failed to disclose that they preferred to invest client money in firm-managed mutual funds and hedge funds, and clients were denied all the facts to determine why investment decisions were being made by their investment advisers.”

Regarding this same case, the SEC’s co-chief of the SEC Enforcement Division’s Asset Management Unit, Julie M. Riewe, said, “In addition to proprietary product conflicts, JPMS breached its fiduciary duty to certain clients when it did not inform them that they were being invested in a more expensive share class of proprietary mutual funds, and JPMCB did not disclose that it preferred third-party-managed hedge funds that made payments to a J.P. Morgan affiliate.  Clients are entitled to know whether their adviser has competing interests that might cause it to render self-interested investment advice.”

The problem here is that JPMorgan is a repeat offender.

In another instance in September 2013, the SEC said JPMorgan misstated financial results and lacked effective internal controls to detect and prevent its traders from “fraudulently overvaluing investments to conceal hundreds of millions of dollars in trading losses” in what the SEC said was a “complex portfolio.”  Yet anyone who has seen a trading operation knows this is like forgetting to add sugar to a brownie mix, but somehow JPMorgan’s well-paid trading management team did not know the real value of the securities being traded.

Even worse, JPMorgan hid the extent of the problem from its own board of directors.  “While grappling with how to fix its internal control breakdowns, JPMorgan’s senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company’s problems and determine whether accurate and reliable information was being disclosed to investors and regulators,” George S. Canellos, co-director of the SEC’s Division of Enforcement, said.

In this instance, JP Morgan violated “a cardinal rule of corporate governance.”  In the earlier example from December 2015, Morgan knew it was deceptively selling more expensive proprietary funds to unsuspecting clients, but continued to do so.

In these two cases alone, JP Morgan paid $507 million in fines, but like the Energizer Bunny, the firm got right back up and will continue to repeat these trading violations again in 2016.  That’s a given since, like the scorpion, it’s in JPMorgan’s corporate culture to victimize the unsuspecting, including its own clients, shareholders and employees.

Glass-Steagall Would Improve Chances for Adopting the Fiduciary Standard

This observation also helps explain why JPMorgan and many other investment banks oppose the fiduciary standard. Creating full conflict-of-interest disclosure to the unsuspecting will devastate their bottom lines because trading is always about getting the edge on the opponent. This means large banks are in a constant adversarial relationship with their own customers. Of course it’s about the extraordinary amounts of money paid in salaries, bonuses and perks to the employees who commit the violations, but it’s also about a culture where there is no accountability for individual violations.

That why advocates for the fiduciary standard should realize that enacting a fiduciary standard will only happen if large banks are broken up.

Re-establishing Glass-Steagall (which was repealed in 1999 by Bill Clinton) would accelerate the adoption of the fiduciary standard. Maintaining the current system, which bailed out the too-big-to-fail banks, only made them less accountable to everyone except their own inner circles.

In the current 2016 presidential campaign, no Republican is in favor of re-establishing Glass-Steagall and they are joined by Democrat Hillary Clinton. However, Bernie Sanders and Martin O’Malley favor its re-introduction.

So the next time we see another big bank cited for SEC violations, we can rest assured that nothing has changed. The perpetrators will be familiar names, but there will always be new victims.

This means financial firms can contribute without any public recrimination when they donate to lobbying forms pushing against pro-consumer actions, such as fiduciary disclosure.

This is a major setback for individual investors and the pro-fiduciary disclosure advocates which will now be out-gunned by well-paid lobbyists and their mis-information campaign against the DOL and SEC efforts to push for any modicum of support for the fiduciary standard.

This buried provision was inserted into the Omnibus spending bill by Republicans in an effort to derail any of the few SEC’s pro-investor initiatives.

As shown in the provision’s language, Section 707  prevents the SEC from using its funds in any way that make it easier for individual investors to track which of their own investment firms are extracting fees and other expenses from individuals’ accounts and then converting those revenues as payments to anti-investor lobbying firms.

This is part of the perverted system by which the nation’s largest financial firms, banks and mutual fund companies take investors’ fees and use them to deceive and manipulate individual investors and those few well-meaning financial professionals who have adopted and endorse the fiduciary standard as Registered Investment Advisors (RIAs.)

To combat this adoption of any new pro-customer standard, financial services lobbyists, including those representing mutual fund companies, hedge funds, insurance company, investment banks, regularly conduct lobbying campaigns to protect their interests. Their efforts are so successful that according to Open Secrets, “the financial sector is far and away the largest source of campaign contributions to federal candidates and parties, with insurance companies, securities and investment firms, real estate interests and commercial banks providing the bulk of that money.”

Even the Investment Company Institute (ICI), the  leading trade association of the $18 trillion in assets (as of year-end 2014) mutual fund industry has shown its distain for individual mutual fund shareholders.

In a letter to Congress, the president of the ICI went on record as opposing the Department of Labor’s pro-investor disclosure rules that basically would force financial sales people to work in the best interests of their own clients.

But the ICI is only one example of how the investment industry victimizes its own customers. Here is a list of the major Washington lobbying firms  and investment firms that are the beneficiaries of Section 707’s Limitation on SEC Funds. These firms gladly and knowingly go to work every day to deceive and manipulate unsuspecting and uninformed individual investors.

No wonder there is a retirement crisis in the U.S. and no one is talking about it.   All this is happening as the nation’s major financial institutions continue their deception campaign against their own unsuspecting investors and mutual fund shareholders.

It’s quite a system.

U.S. economic growth in 2016 was cut to 2.4%, a decrease from a previous estimate of 2.8%, according to a report by Goldman Sachs in September 2015. On a global level, GDP growth was cut from 4.3 %  to 3.7% primarily due to a slowdown in China and prospects for gradually rising U.S. interest rates.  Rising U.S. rates have not occurred for about a decade. Similarly, Barclays bank said investors should prepare for “mediocre” returns in 2016, while some economists are even predicting another recession.

A low-return environment is unwelcome news as more people enter retirement and for those already not working who face a wall of fixed expenses.  Every day, an estimated 10,000 Baby Boomers (those born between 1946 and 1964) enter retirement at age 65, according to the Pew Research Center. These are people who are exiting the workforce and will now have to test whether their lifelong savings disciples worked in conjunction with their investment acumen.

But for the majority of Americans, the size of their retirement portfolios will not be enough, according to a number of authoritative sources. The Federal Reserve reports the median balance of retirement accounts held by Americans saving for retirement totals less than $60,000.  In more specific terms, the Fed found that the median account value for those 35- to 44-years-old is a scant $42,700, while the median value for those 55- to 64-years-old is $103,000

According to a paper by Boston College’s Center for Retirement Research, about 50% of all households are at risk of not being able to live a financially secure retirement, up from about one third in 1983. This dismal projection is based on the College’s National Retirement Risk Index that compares projected income replacement rates for working-age households aged 30-59 to target income replacement rates. These income replacement rates would allow households to have the same consumption levels after they retire as they did before. The Index measures the percentage of households that fall more than 10% below their target.

This paper, “Falling Short: The Coming Retirement Crisis and What We Can Do About It,” Alicia Munnell, lists a number of reasons for the retirement income shortfall (the demise of pension plans, higher medical costs, longevity, changes in Social Security, taxation of benefits), but the net effect is that even with 401(k)s in place, the retirement income shortfall is growing.

This is a problem which has been building for years. Among the paper’s key conclusion is that “As a result, in 2013, the typical working household approaching retirement with a 401(k) had only $111,000 in combined 401(k) and IRA balances.  This amount translates into less than $400 per month, adjusted for inflation, which will not provide a sufficient supplement to Social Security benefits.”

In more dramatic terms, the study found that the median 401(k) balance for people with 401(k)s was only $111,000.

401(k)/IRA Balances for Median Working Household with a 401(k),

Age 55-64, by Income Quintile, 2013

Source: Alicia Munnell’s calculations from U.S. Board of Governors of the Federal Reserve System, Survey of Consumer Finances (2013). Cited in the paper “Falling Short: The Coming Retirement Crisis and What We Can Do About It,” Alicia Munnell, April 2015.

While 401(k) balances are not a family’s only assets, (they exist alongside home equity, savings, Roth IRAs, pensions, etc.) 401(k)s are a bellwether of liquid assets and household savings patterns.  The largest asset for most households in home equity (less the mortgage amount due to the lender), but this can only be tapped via home equity loans.

A 2014 study from the Center for Economic Policy and Research found that the median net wealth of households headed by someone between the ages of 55-64 and approaching retirement was $165,700 in 2013, a decrease from $177,500 in 1989. The middle sample of homeowners in this age group had a 55% equity stake in their homes in 2013, down from an 81% in 1989. The non-housing wealth of this group in 2013 averaged $89,300, down from a peak of $160,700 in 2004, showing the result of the 2007 recession on both equity portfolios and real estate.

Unfortunately, the Center for Retirement Research paper falls far short in its recommendations about how to correct the retirement problem.  The paper lists the well-trodden, traditional politically-correct suggestions—work longer, save more and use home equity loans to fill the retirement income gap.

Working for Better Solutions to the Retirement Crisis

The suggestions contained in this otherwise thorough academic paper are politically timid and are not the best solutions to the retirement crisis since they only ask American workers to sacrifice more in retirement than they did when they were working. Again, this paper, like most of the “401(k) education” offered by corporations to their employees approaching retirement, the lessons all focus on manipulating the very few monetary variables open to workers.

In these corporate “educational” settings, facilitators avoid any discussions about the lack of overall company wage increases, corporate policies that decrease benefits and shift payments to workers, the pay of top executives compared to average workers, corporate lobbying activities that frequently develop policies that are anti-average worker, and federal and state fiscal policies that work against the economic benefit of average Americans.

In short, these 401(k) “educational” programs have the potential to become excellent starting places to embolden workers to see the world and their company in new refreshing ways.  But that opportunity is wasted when these “educators” frame the retirement crisis issue in ways that only build the feeling of financial hopelessness among their own 401(k) participants.

Given the presidential election focus on national policies, correcting the nation’s dismal retirement savings prospects must address the real issues of wage stagnation, the growing income disparity and the greed of the top 1%.  For instance, how can a 401(k) “educational” class not mention the fact that 0.1% of American families enjoy almost as much as wealth 90% of the rest of the country combined, according to Democratic presidential candidate Bernie Sanders (D-Vt.) and verified by the Washington Post. Doesn’t this concentration of wealth impede economic and political opportunities for the majority of Americans?

However, when there are no increases in wages, savings rates and retirement portfolios stagnate. Retirement savings rates undoubtedly can be accelerated via combining higher savings rates with the magic of compound interest, so boosting the savings rate gives investors better odds of building portfolio wealth over time.

Payroll tax rates should also drop to increase take-home pay. Those diligent saver-investors must also find low-expense mutual funds or exchange traded funds (ETFs) to invest in since fees and expenses are the only variable in the investment world they can directly control.

It’s also important to get investment advice from an advisor who openly displays their practice as one which puts the needs of the client-investor ahead of their own.  Investors must ask if the advisor adheres to the fiduciary standard and if so, they should ask for a signed statement from them saying that they will put the clients’ interests ahead of their own.  Currently, only Registered Investment Advisors (RIAs) who are regulated by the Securities and Exchange Commission or state securities regulators adhere to the fiduciary standard, which means they must act in their clients’ best interests.

To protect themselves, investors have to ask their financial representatives tough questions, but these are tough times. No one will protect your money like you do.

Unfortunately, the financial services industry has done too little to convince their own customers that they elevate their interests ahead of the investment firm and its own financial planners or financial advisors. Now, as the financial services industry is engaged in an all-out lobbying and PR campaign to eliminate the fiduciary standard advocated by the U.S. Department of Labor, it’s time for investors to protect themselves.

The lesson that lower future economic growth projections, combined with lower returns on investment portfolios, means that most people will have to get by on less income. Unless something dramatic happens in the political policy world, this will become the new American way.

In a recent letter to Congressional committee, the president of the Investment Company Institute (ICI), the mutual fund industry’s leading lobbying group, went on record last week as opposing the Department of Labor’s pro-investor disclosure rules that basically would force financial sales people to work in the best interests of their own clients.

Now, in most other professions, such as medicine, the law, and even the food services industry, this position is a no-brainer.  It is a given that a doctor would prescribe the most appropriate therapy for an illness since the doctor’s credo of “do no harm” should be observed at all times.  Lawyers also have a professional obligation to provide the best defense possible for their clients.  Malpractice lawyers are available in both industries to keep errant professionals in check and recover damages for the aggrieved.

But the financial services industry is different.  It is a sales profession. Selling dominates success and determines careers.  So given the opportunity, some financial professionals (and no one knows how many) do bad things against their unsuspecting clients by selling them inappropriate, expensive mutual funds, annuities, or other investments, such as limited partnerships or leveraged products.

In short, they can often violate their fiduciary duty, which is embedded in many other professionals that deal with money, such as estate and probate lawyers, bankers, accountants, and trustees.

Focusing on Commissions and Fees

Instead, the commission-based investment sales industry gives financial sales people broad authority to sell whatever meets basic client needs, regardless of whether another better or cheaper alternative is available. There are no established or enforced rules that simply state an advisor has to sell a mutual fund with the lowest expense ratio and fees in a fund sector given similar performance and risk data over time and different market cycles.

Worse, in addition to commissions, there is a thicket of hidden 12b-1, management, redemption fees, revenue sharing deals, loads, charges, and fund operating expense considerations that all can reduce an investor’s net return.

Mutual fund fees are critical for a few reasons:  They affect net returns and they are one of the few variables investors can control.

How bad is the impact of mutual fund fees on an investor’s return?  In one DOL example available in “How 401(k) Fees Destroy Wealth,” a 1% difference in fees over 35 years with an account balance of $25,000 could reduce an account balance by 28% over the period. 

There are numerous stories about the acidic impact of fees on investor returns. The most recent appeared on CNBC  Nov. 5, 2015 and quoted from a Morningstar analysis  that found higher-cost funds “are more likely to underperform and ultimately go under than lower-cost funds.”  Academic studies focusing on fees and expenses going back over a decade have found similar results.

Of special interest is the annuities industry which has reputation as being  the Wild West of fees and unscrupulous practices.  In an October 2015 report, “Villas, Castles and Vacations,” Senator Elizabeth Warren (D-Mass.) said annuity

salespeople are receiving kickbacks from annuity sales firms for selling their products over competitors. The kickbacks include free meals, hotel stays, vacations to expensive resorts, gift cards, golf outings and all-expense-paid trips.

And this presents major problems for making full disclosure to clients in the financial sales industry, especially for those who sell annuities and actively-managed, load mutual funds.

Client disclosure is such a serious problem that the investment industry has mounted a major lobbying campaign for the last decade to prevent the adoption of any fiduciary standard that would put the needs of clients ahead of their financial salesperson.

And that is why the head of the ICI, Paul Schott Stevens, and others in the commissioned-based financial industry want to derail the DOL’s thoughtful, industry-reviewed rule that would force financial salespeople to explain fees, expenses, pros and cons of various financial products to their often less sophisticated clients.

In his letter, Stevens (who makes $1.797 million annually as ICI president) said that if the DOL’s proposed rules were adopted in their current form, “it would do great harm.”

Instead, Stevens and other lobbying groups representing financial industry salespeople, said a bill passed by Republicans in the House (H.R. 1090) would push the SEC and the DOL to develop “a harmonized fiduciary duty for all investors.” He did not elaborate on what the harmony would sound like, especially since these discussions have been going on for about a decade. In related testimony presented Sept. 30, 2015, Stevens also challenged the DOL’s data that showed high fees and expenses unnecessarily cost investors $17 billion annually.

He then repeated the financial lobbyists’ unsupported mantra that the proposed shift from shifting most small investors (those with portfolios under $100,000) from commission-based advice to fee-based accounts would be a costly expense for investors. The ICI is a great source of industry data and Stevens said the proposed DOL rules would affect 65% of households with IRAs valued at less than $100,000. This would cover some 22 million households.

“Taking these two factors together, we submit that far from helping savers, the rule would increase fees and reduce returns, resulting in $109 billion in net increased costs to American workers over 10 years,” he said.

Why would investors pay these increased costs? Because financial salespeople would see a loss in income (due to a drop in sales) and lost commissions because they would have to sell products that were more suitable, and often less expensive, for clients. To fill this financial void, lobbyists are asking investors to compensate financial salespeople for their lost commissions. Stevens did not say what would account for the lower portfolio returns, but industry professionals have long said that a decline in fees produces a higher net return for investors.

The DOL’s well-publicized and widely discussed rule proposal is to implement a fiduciary standard that gives uninformed investors objective information.  How this straightforward proposal would prevent investors with less money from getting personalized, cost-effect investment advice has not been fully explained. Maybe it is because commission-based advisors don’t want to spend time with people who have small portfolios, unless they are compensated by selling  higher commission, often ill-suited products. That seems plausible, but it cannot be said publicly.

In a reversal of the facts, Stevens said the Republican House bill to eliminate the pro-investor fiduciary standard would really be the financial sales industry’s way “to get the fiduciary rules right.” But “right” for who: investors or the investment industry?

Conflicted Lobbyists

The problem with conflicted, often self-serving industry lobbyists, like the ICI, is that they always present their positions from their respective industry’s perspective.  The ICI is in a politically difficult position since they are paid by the industry, but have to publicly support industry customers. The problem is they cannot simultaneously serve two masters. As a result, no one speaks forcefully for individual investors.

If the ICI had any long-term vision, they would address the nation’s looming retirement crisis, including problems in the 401(k) sector.  A recent Bloomberg News report  by Carol Hymowitz found that half of U.S. workers lacked company-sponsored retirement plans, while 45% of businesses with fewer than 100 employees offer 401(k)s. This is a much larger national problem and one which should concern any industry group which has a long-term vision for their overall constituency.  But the ICI’s position on this issue shows it is more concerned about protecting the commissions of financial salespeople.

Giving objective advice to investors should not produce a corresponding increase in costs to investors.  They should have been getting objective advice in the first place.

Now, the lobbyists are asking investors to compensate financial salespeople for lost commission-based income that happened when they were sold less-then-optimal products in the first place.

Lobbyists like to blame the victim, but in this case, the financial industry is also asking the victims (individual investors) to compensate their offenders (commission-based salespeople) and that is not a burden for individual investors to assume.

Lobbyists Who Work Against Individual Investors

Securities Industry and Financial Markets Association (SIFMA)

The American Bankers Association (ABA)

American Council of Life Insurers (ACLI)

American Retirement Association for Advanced Life Underwriting (AALU)

Bond Dealers of America (BDA)

Financial Services Institute (FSI),

Financial Services Roundtable (FSR)

Investment Company Institute (ICI)

Investment Program Association (IPA)

Insured Retirement Institute (IRI)

National Association for Fixed Income Annuities (NAFA)

National Association of Insurance and Financial Advisors (NAIFA)

The National Association of Real Estate Investment Trusts (NAREIT)

The Real Estate Roundtable

The U.S. Chamber of Commerce