You'll Never Guess What's Eating Away at Your Retirement Savings

Imagine there were two different kinds of doctors -- "Doctors" and "doctors". Both have shiny offices, conduct fancy medical tests, recommend procedures, treat you, and are otherwise indistinguishable.

Only three major differences exist between them:

  • Doctors have to give advice that's in your best interest. doctors don't.
  • Doctors are paid for examining and treating you. doctor's visits are free, but if you want treatment, you pay a bunch of extra money to medical device and pharmaceutical companies who pay the doctor kickbacks for recommending their products.
  • People who visited Doctors on average get better medical care for less money than they do with doctors.

You'd probably want to go with the Doctor. But what if it were difficult to tell Doctors and doctors apart?

Welcome to the doctor's office.

It probably seems like your financial advisor is a Doctor -- someone whose job is to give you the best advice they can, not someone paid to sell you specific investments.

But that may not be the case.

Many advisors -- so-called non-fiduciaries -- don't have to give advice that's in your best interest. What's more, they often earn the bulk of their income from the very funds they recommend you buy.

Rising monthly quotas and sales bonus targets can dictate how much of a particular fund an advisor needs to sell.

"Preferred" mutual fund partners even sometimes award cash bonuses and vacation prizes to advisors who sell a lot of their funds. It's like if Pfizer paid your cardiologist for his ability to generate sales, plus golfing trips to Torrey Pines for meeting that July stretch goal of 100 Lipitor customers. You'd rightly be suspicious.

A recent report (opens PDF) by the Council of Economic Advisors conservatively puts the cost of conflicted advice to IRA investors at $17 billion per year.

Let's say at age 45 you roll over your 401k into an IRA with an advisor who -- unbeknownst to you -- gives conflicted advice. By the time you reach 65, you'd have, on average, 17% fewer savings.

That's huge. If you had rolled over retirement savings of $100,000, then by age 65 you'd have missed out on $55,000.

Source: Author's calculations, CEA.

The shortfall would continue to compound over your lifetime. If you went on to reach the age of 95, you'd have had one-quarter less money to withdraw during retirement.

What explains such dramatic underperformance? Conflicts of interest and expensive, non-transparent fees. One academic study found that for every half-percentage point increase in fees a fund generates, non-fiduciary advisors recommend their clients allocate an additional 17 percentage points to the fund.

Another found that non-fiduciary advisors rarely recommend lower-cost index funds over actively managed funds. Even when mystery shoppers walked into the door with a well-diversified, low-cost portfolio, advisors steered them into higher-fee portfolios:

Overall these results are in line with an interpretation where the advisor's goal is to maximize fees by placing more weight on actively managed funds that create more income for the advisor.

This sounds crazy.

It's supposed to be illegal, too.

A1974 law requires all advice on retirement accounts to be in your best interest. But the rules were written 40 years ago, and advisory firms have devised enormous loopholes. For example, an advisor can escape his fiduciary obligation to put you first if the advice isn't given on a "regular basis". So self-serving advice on big one-time transactions like rollovers and annuities are fair game. Or an advisor can just bury a fineprint disclaimer indicating that his advice shouldn't count as the "primary basis" for making your investment decision.

Meanwhile, the shift in retirement savings from defined benefit pensions to 401ks and IRAs means that we rely on retirement advisors more than ever before.

Of course, many non-fiduciary advisors try their best to do right by their clients. Still, the fact remains: An "advisor" may sound like someone whose job is to recommend what you should do, but non-fiduciary advisors are only legally required to recommend a "suitable" thing to do, which is on average a costlier thing to do. There's make-believe reality, there's legal reality, and there's reality reality.

Telling Doctors from doctors

To get a deeper sense of the problem, I surveyed roughly 850 Motley Fool readers about their financial advisors.

Although previous studies have shown that it's difficult to tell the difference between fiduciary and non-fiduciary advisors, I was curious whether the same would be true for Motley Fool readers, active investors who tend to be more engaged with and knowledgeable about their finances than most individual investors.

If even Motley Fool readers couldn't tell the difference, that would help prove that the fault isn't with investors, who hypothetically might decipher the legal gobbledygook with just a little more financial education and fine-print disclosure, but with advisory firms that engineer ambiguity.

Maybe the very notion of a "financial advisor" whose job isn't really to give you their best financial recommendations is inherently misleading.

Here's what I found.

The vast majority of investors thought that their advisor was required to put them first. And nearly everyone thought that advisors should be required to put their clients' interests first.

Yet only one-third of investors knew how to determine whether that was actually the case. Alarmingly, more people said their advisor was required to put them first because "I trust and depend on him/her" than gave the correct answer.

* Percentages don't add up to 100% because respondents were allowed to give multiple answers.

And investors do rely on their advisors advice. Most bought a mutual fund based on their advisors recommendation, but only one-third thought they knew how much their fund cost and named a price under 1% (which is higher-than-average).

So investors depend on their advisors, and believe their advisors are required to be loyal, but don't know how to tell whether that's actually the case.

Of course, this makes total sense. Why would investors know the difference between an "investment advisor" who's a fiduciary, and a "financial advisor" who technically isn't? Why would investors know that the latter gets paid by the funds they recommend for whatever fees they generate? Most people aren't lawyers. (And most lawyers don't even know this stuff.)

No matter how much the fineprint equivocates, "clients" will naturally assume "advisors" recommend what they should do -- not what would be an OK thing to do; that's what the word "advisor" means.

The social critic Neil Postman observed in his book Crazy Talk, Stupid Talk that people in different roles often interpret the same situation in different ways: "Each constructs a different metaphor for what is happening."

He writes,

This sort of creatively misleading aura suffuses so much of the nutty financial advice industry. See if you can come up with a few fitting metaphors for how these advertisements depict advisors:

Advisors, we are told, are like friends, neighbors, therapists, teachers, life coaches -- loyal professionals who will put your financial mind at ease because you can trust them.

That's a great standard. Let's hold them to it.

Here's what you can do:

Right now, for the first time in history, the Department of Labor is seriously considering closing the loopholes that allow conflicted advice on retirement accounts.

The article You'll Never Guess What's Eating Away at Your Retirement Savings originally appeared on

Ilan Moscovitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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