Over the past 30-plus years, the science of behavioral finance has repeatedly demonstrated how human nature interferes with our ability to make smart investment decisions.

Now the federal government has finally agreed. Recently proposed regulations essentially acknowledge that:

1) Investors often make bad/dumb decisions

2) Input from a professional advisor can prevent this from occurring

3) This should significantly increase the amount of money people will have when they retire

A Hope and a Prayer

Consider this: According to the Employee Benefit Research Institute, as of the end of last year, Americans had $4.5 trillion in 401(k)-type plans offered through the workplace. Next to their home, for most people, this money represents the largest single asset they own.

Yet most of us have never received any personal advice about how to invest this money! We’re essentially flying blind and hoping for the best.

Don’t blame your employer. Concern that individuals would be steered to investment options that would benefit the advisor more than the employee led the government to enact strict and complex rules about how advice could be offered, as well as severe penalties for not following these to the letter.

The vast majority of plan sponsors -- and financial advisors -- concluded it simply wasn’t worth the risk, even though employees repeatedly expressed a desire for help.

Advice, With Safeguards

A provision tucked inside the Pension Protection Act [PPA], a massive piece of legislation passed two years ago, is about to dramatically change this -- not just for those with money in an employer retirement plan, but also for those who save through an Individual Retirement Account, or IRA.

PPA outlined two ways that retirement-plan participants could be offered advice without the employer or advisor being held liable if the recommended investments didn’t perform as expected:

1) An advisor could base his/her recommendations on a computer model that is certified each year by an independent third party, or

2) The compensation paid to the advisor could be set at the same level regardless which options in the plan were recommended

Congress left it up to the Department of Labor to spell out how this would work in the real world. In announcing the proposed rules, DOL made it clear that they apply to retirement plans in general -- including IRAs.

Potential Impact

According to DOL, today only about 40% of participants in 401(k)-type plans are offered investment advice. It estimates the protections offered to both professional advisors and retirement savers will boost this to 60%.  

Even more significant is the projected increase in the value of retirement accounts. Bradford Campbell, an assistant secretary with the Department of Labor, says working with a financial professional will help workers “avoid mistakes that reduce returns and understand fees better so they make better-informed decisions.”

The end result: after fees, workers could end up with $10 billion more in their retirement accounts.

What to Expect at Work

If the proposed regulations are adopted, your employer could announce as early as mid-2009 that you now have the option of meeting with a financial advisor. If you don’t hear anything on the subject, that could be because some employers may not know about the rule change; others might need a nudge from employees. 

Some companies will still be reluctant to venture down this path. That’s because if a complaint arose, your employer would have to justify the criteria used to select the advisor who was chosen.

If a financial professional is made available, s/he would be required to clearly disclose how s/he is being paid. 

In addition, expect detailed questions about such things as your age, marital status, expected retirement date, risk-tolerance, investment experience, savings goal, your estimated retirement income need, etc. These data would be fed into the computer program or, in the case of a “flat fee” arrangement, the advisor would factor them into the recommendations about how your 401(k) account should be invested.

Should a complaint arise, in order to avoid personal liability, an advisor must be able to demonstrate that the recommendations were, in Campbell’s words, “consistent with generally accepted investment theory.”

Changes for IRA Investors

Individuals who invest for retirement via IRAs could see the biggest change because, often, you don’t get personalized advice. Since the amount being invested is relatively small, practically speaking, an in-depth analysis of your particular financial situation is usually not worth an advisor’s time.

If you’ve ever walked into a bank in early April to make your annual IRA contribution, you might have experienced this. Think back: did the bank representative fill out the application form, ask you a couple of general questions, and then tell you to put the entire amount in a single mutual fund?

If these regulations take effect, that’s no longer going to be acceptable. Investment recommendations about any kind of retirement account would have to be based on either a computer program or a detailed and documented analysis by the advisor.

(In fact, this is the case under current law. Who knew?!  However, policing IRA advice falls to the Internal Revenue Service, not the Department of Labor. This simply hasn’t been a top priority.)

Do-It-Yourself is Still an Option

If and when these regulations take effect, you will still be free to make your own investment choices -- and live with the consequences. Furthermore, a financial professional who simply helps you own an account and does not make any investment recommendations, has no liability.

DOL expects most investors offered advice to accept it. 

“Sixty-five million people are in plans where they are directing their own investments,” says Campbell. This proposal is aimed at “ensuring participants that they’re getting good advice from knowledgeable persons and that advisors are accepting responsibility” for their recommendations.

* Maximum 2008 IRA contribution: $5,000       Those age 50 and older: $6,000