Stay the course, pay attention to the big picture, and don’t sweat the details. That string of mantras makes sense for saving and investing, but only up to a point.
Once you start paying attention to fees, it becomes clear that the details really matter.
Years ago, I began to notice that although I was faithfully socking away money into an I.R.A., my account wasn’t growing much — not compared with the overall returns of the stock and bond markets.
Something was holding me back. The main problem turned out to be fees, a whole constellation of them. No single charge was a deal breaker, but over time the damage was large.
That is a sad truth of investing: Niggling little fees weigh heavily over extended periods. The addition of a mere 1 percent in fees annually, over a 35-year career, can reduce your nest egg by 28 percent, according to calculations by the Labor Department. Higher fees than that are common and hurt even more. In fact, if you take the time to look at the math, you may conclude that seemingly minor fees are far more dangerous than you think.
In an ideal world, you wouldn’t have to worry about pesky details like mutual fund commissions and fees: You could stuff savings into a reliable fund and reap the rewards when you need the money later. You could, in short, assume that the people handling your investments were always acting in your best interest.
But we don’t live in that kind of world. Even with the prospect of tighter requirements for financial advisers beginning next year, investors need to watch out for themselves. As I wrote recently, the Labor Department has proposed rules that should provide a greater degree of protection for many investors starting in April 2017. That assumes that the rules are not watered down further or blocked by the financial services industry.
If the rules do take effect, financial advisers dealing with retirement accounts will generally be required to act as fiduciaries: That is, they will be required to act in a client’s best interest. That is a major step forward, but the rules contain glaring exceptions. For one, they don’t affect non retirement accounts at all; the Securities and Exchange Commission, which could institute a universal fiduciary requirement, hasn’t done so.
Even for retirement accounts, the Labor Department’s rules contain vagaries and loopholes. For example, they don’t say what specific fee levels are permissible or how “best interest” is to be construed. And they give brokerage firms a way of defining the requirement to act in the best interest of existing customers through what is known as “negative consent.”
In practical terms, this means that if you have a current brokerage account and don’t respond in writing to the broker’s document, you have given your consent. Next year, expect to receive a document outlining this reality from your investment firm, said Marcia Wagner, a Boston lawyer who is an expert on the law governing retirement investments. “People should become aware of this problem right now,” she said. “They should be on the lookout for communications from their advisers next year — and everybody should respond. If you don’t, you’ve signed off on whatever your financial adviser may be doing in your account, and that may not be the best thing for you.”
Not everybody responds in writing to boilerplate notes from brokerage firms and financial advisers, said Jerry Schlichter, a St. Louis lawyer who has been a pioneer in class-action suits involving excessive fees in 401(k) retirement accounts. “Behavioral economics tells us that in a situation like this, many people won’t even read the documents, and that is a big problem with the rules as they now stand,” he said.
When and if the rules eventually do take effect, he said, “it will be important for the Labor Department to a send a signal that it is serious about them” by taking enforcement action. And if it becomes clear that “companies or individuals have engaged in systematic violations,” he said, the new rules raise the possibility of class-action suits on behalf of investors with I.R.A.s.
In May 2015, Mr. Schlichter won a landmark decision before the Supreme Court, which held that in 401(k) accounts, sponsors have “a continuing duty” to act in employees’ best interests, by monitoring investments and removing “imprudent” or needlessly costly ones.
What will constitute a violation under the new rules isn’t entirely clear, partly because they aren’t final and haven’t been tested.
Knut Rostad, founder and president of the Institute for the Fiduciary Standard, a nonprofit advocacy group, said, “It will take months, if not years, before the precise meaning of the rules is determined — in many cases, in the courts.”
In his view, investors should act now, on their own behalf, to make sure that they are being given a fair shake. They should, he said, demand that their advisers do three things: provide a written pledge to uphold a fiduciary standard, disclose potential conflicts of interest as well as an indication of how such conflicts will be remedied, and clearly list all investment costs.
Many of these costs are lurking somewhere on a firm’s website or in a mutual fund prospectus or supplemental document, which few investors locate and read. An earlier version of the Labor Department’s new rules would have required routine publication of such expenses, and projected returns, in regular account statements, but it was removed under pressure from financial firms.
And so, unless they check for themselves, investors may not always understand when they are paying needlessly high fees, like “loads” or commissions on mutual funds.
Until the late 1970s, nearly all funds were sold with loads averaging about 8 percent of the value invested in a fund — and they were imposed at the “front end,” meaning if you walked in the door of a brokerage firm with $1,000, you walked out with $920 in a mutual fund. Plenty of no-load funds — those without such commissions — are sold today. Among them, index funds generally have very low fees. Over extended periods, index funds have usually outperformed most actively managed funds, especially those with high fees.
But hundreds of funds with loads of at least 5 percent are still being sold, according to an analysis provided to me by Laszlo Birinyi Jr., president of Birinyi Associates, a research firm in Westport, Conn. For the most part, these fees have meant more money for the fund managers and advisers and less for investors.
Presumably, advisers acting in investors’ best interests would need to examine such costs carefully. “With the new Department of Labor rules coming into effect, I wouldn’t want to be in the position of trying to sell load funds,” Mr. Birinyi said.
In addition, hundreds of funds are sold with another kind of charge, known as a 12b-1 fee: a fee of up to 0.25 percent that quietly saps fund returns for years. Currently, the pernicious effects of loads and 12b-1 fees tend not to be clearly shown in standard investment returns.
The new rules may be an improvement, but it’s already evident that they won’t be enough. Advisers with investors’ best interests at heart can help. But investors will also have to peer through the murk of conflicts and excess fees and find ways to help themselves.
Correction: May 15, 2016
An article last Sunday about the Labor Department’s new rules for retirement accounts described the negative interest clause incorrectly. It requires a brokerage firm to act in an investor’s best interest; it does not eliminate that requirement.