Fee compression: Bad for retirement savers? – Carosa

The client sat across the table from the adviser. She said, “We’ve been talking to other firms. We like you, but we need you to match their fees.”

“Sure,” said the adviser. “What are the fees they’re offering?”

“10 basis points,” said the client.

“Can’t do it,” said the adviser without hesitation.

This is an interesting example of what it means to be a good fiduciary. It’s also a problem we’re seeing with increasing frequency (see “Exclusive Interview: NAPA President-Elect Jania Stout Explains How to Keep HSA From Cannibalizing Retirement Savings,” FiduciaryNews.com, July 17, 2018).

Let’s make this quite blunt: A fiduciary is not a commodity. You cannot in good faith offer the service based on the lowest bid. If a client or prospect thinks that pricing is important, a good fiduciary will walk away.

Why? There’s an old adage that says there’s no such thing as a free lunch. Explained via another cliché, this one from the famous Fram oil filter commercial, “you can pay me now or pay me later.” Either way you’re going to pay for that lunch. The question is will that payment be open and transparent, or will it come up unexpectedly in a surprising and potentially damaging place?

Being an investment adviser means being open for business 24/7. This is what “ongoing supervision” means on the SEC’s Form ADV. Unfortunately, this means the hourly rate for offering ongoing supervision approaches zero, no matter what the actual dollars in fees collected. This is also why an investment adviser that is providing “ongoing supervision” cannot charge an hourly rate – clients cannot afford to pay hourly rates when the service is being provided 24 hours a day for seven days a week.

A good fiduciary must always serve the best interests of the client. Within the operational definition of “best interests” includes terms like “consistent” and “reliable.” These two terms therefore require the fiduciary to adopt a business model that is sustainable. Speaking plainly (i.e., you don’t need an MBA to understand this), any business model that can devolve into a commodity is not sustainable.

Again, a fiduciary is not a commodity. Here’s why. Combine “consistent” and “reliable” with “ongoing supervision” and “open for business 24/7” and you begin to see why a fiduciary service demands a premium price. Smart buyers – those that understand what a fiduciary really offers – understand this.

Not only smart buyers, but the DOL understands this, too. Early drafts of the 2012 401(k) Fee Disclosure Rule contained language that implied plan sponsors must always seek the lowest fee. When the ramifications of this were brought up to the DOL, the DOL changed the language. They specifically added the caveat that the lowest fee is not the appropriate measure. The DOL instead instructed plan sponsors to review fees in terms of the value of the service.

In other words, you get what you pay for. If you simply want a firm to execute trades for you (i.e., you’re not looking for a fiduciary), then paying less than $10 a trade is an appropriate fee benchmark. If you see a fiduciary adviser to continually monitor plan mutual funds, then an AUM fee of 30 basis points allows that adviser to maintain a sustainable business. (Similarly, and this often doesn’t occur in menu-based 401(k) plans, if the plan sponsors want customized stock/bond portfolios, then paying a fee of 1% on the first million would be normal.)

These fee rates offer the margins that produce ROIs that allow fiduciary advisers to sustain their business model. If a client demands a fee rate that eats into these margins, accepting that client places the business at risk. This is not in the best interest of that particular client. It’s also not in the best interest of all the other clients at the firm.

And this is how fee compression can hurt retirement savers.