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Retired Investor

You May Need a Different Kind of Financial Professional for Retirement

For those who are soon to retire or have recently retired, there is an inflection point between receiving a paycheck from an employer and a paycheck from your portfolio. What type of financial service is best for the retiree who needs to “live off of” their investments?

by Julie Jason | January 2020

 

For those who are soon to retire or have recently retired, there is an inflection point between receiving a paycheck from an employer and a paycheck from your portfolio. For retirees who rely on their investments for retirement income, it is also one of the riskiest, if not the riskiest, time in an investor’s life. After all, you won’t go back to work for 45 years to recover from mistakes.

What type of financial service is best for the retiree who needs to “live off of” their investments?

By the Numbers

According to the U.S. Securities and Exchange Commission (SEC), registered investment advisers are growing in number, while the number of broker-dealers is declining. The SEC has stated that this “likely is a reflection of the market for investment advice, and potentially of the choices available to retail investors [that’s you] regarding how to receive or pay for such advice, the nature of the advice, and the attendant conflicts of interest.”

Over the last 14 years, the number of broker-dealers fell from over 6,000 in 2005 to less than 4,000 in 2018. At the same time, the number of investment advisers registered with the SEC rose from about 9,000 in 2005 to 13,300 in 2018. The 563 dually registered firms (both broker-dealers and investment advisers) hold over 90 million (63%) customer accounts, according to the SEC’s “Regulation Best Interest: The Broker-Dealer Standard of Conduct.”

The 770-page length of the release will tell you that this is a complicated topic that took careful consideration by regulators; however, if you want context, the introduction and background are only a few pages long and worth your time. You may also want to read comment letters from the public and the industry; there are thousands to choose from, including mine.

Do Retirees and Pre-Retirees Need Different Advice?

If you think about the nature of services pre-retirees and retirees need, do they differ? Before retirement, investors are getting recommendations from their financial professionals to buy stocks, bonds, mutual funds and the like; the primary goal is to grow capital. These are transaction-based recommendations that are the province of broker-dealers (brokers).

After retirement, investors with wealth switch to a different objective—protect capital, create income that can support living expenses and at the same time grow capital for a retirement that may last decades and far beyond, if there are legacy and charitable interests. The management of that enterprise is the province of registered investment advisers. While there may also be the need for transaction-based recommendations, such as the purchase of an annuity, there is a need for a more global and strategic approach, namely the structuring, monitoring and management of the retiree’s portfolio for a lifetime.

Broker-Dealers Versus Registered Investment Advisers

So, let’s tackle this question: What are the differences between registered investment advisers and broker-dealers and what could that mean to someone approaching or already in retirement? Most people don’t know.

A RAND study concluded that investors did not understand the differences between broker-dealers and investment advisers and that common job titles contributed to investor confusion. Focus group participants did not understand the term fiduciary, or how the fiduciary standard differed from suitability. Confusion about titles, services, legal obligations and compensation persisted even after a fact sheet on broker-dealers and investment advisers was provided to participants. (For more information on studies, you’ll want to read the SEC’s April 18, 2018, Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles.)

The SEC wants to improve investor understanding of the financial industry through a series of recent regulatory changes, such as new disclosures called the CRS (Customer Relationship Summary) that applies to both brokers and investment advisers.

The good thing about the CRS is that any confusion that someone has about whether they are currently working with a broker or adviser will be addressed by it. The firm you currently work with will provide you with a CRS in the summer of 2020; it will explicitly state the firm’s role (broker-dealer, investment adviser or dual registrant).

The CRS also points out key information that defines the financial firm’s relationship with its clients, including conflicts of interest embedded in the relationship.

There are differences in services and obligations and that should matter to every investor, especially to someone who is investing for retirement security, which calls for the ongoing management of a personal portfolio. The differences have to do with transactions versus ongoing advice.

The SEC’s Best Interest release states, “Broker-dealers typically provide transaction-specific recommendations and receive compensation on a transaction-by-transaction basis (such as commissions) (‘transaction-based’ compensation or model). A broker-dealer’s recommendations may include recommending transactions where the broker-dealer is buying securities from or selling securities to retail customers on a principal basis or recommending proprietary products.”

Again, from the Best Interest release, “Investment advisers, on the other hand, typically provide ongoing, regular advice and services in the context of broad investment portfolio management, and are compensated based on the value of assets under management (AUM), a fixed fee or another arrangement (‘fee-based’ compensation or model).”

Which Service Is Right for You?

Of course, what services you want will depend on your unique circumstances. Quoting SEC Chairman Jay Clayton: “It really comes down to what you are looking for, for example how often you plan to buy and sell securities; how involved you want to be in the decision to buy and sell; whether you want someone to manage and monitor your portfolio on an ongoing basis; and whether the costs line up with the services you need or want.”

Chairman Clayton suggested thinking about your situation this way: “Do you want someone managing your account on an ongoing basis based on your broad financial goals and needs and movements in the markets? If so, an investment adviser may be best for you. Or, do you plan to buy a few stocks, bonds, mutual funds or exchange-traded funds (ETFs) and hold them for the long term with a few adjustments over the years? In that case, a broker may be best for you.”

One additional consideration is the standard of care that applies to brokers versus advisers. When the SEC initiated its rulemaking, it addressed who is and is not a fiduciary, which is the highest legal standard of care.

Investment Advisers Are Fiduciaries, Brokers Are Not

Investment advisers are held to the highest standard of care under the law, that of fiduciary. Quoting from the SEC’s Best Interest release: “In the investment adviser context, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘best interest’ of its client at all times.” The SEC’s “Commission Interpretation Regarding Standard of Conduct for Investment Advisers,” effective July 12, 2019, addresses that fiduciary standard of care.

What’s important about these regulatory developments, which were a very long time coming, is this: The SEC established a new standard of care for brokers. The new standard (called Best Interest) is more than the current “suitability” standard, but it is less than a fiduciary standard that applies to registered investment advisers. (“Regulation Best Interest will enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.” June 5, 2019, release, “The SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals.”)

There will be four new obligations for brokers to comply with: disclosure, care, conflict of interest and compliance. What’s most important? From my point of view, conflict of interest.

New for Brokers: Conflict of Interest Obligation

Brokers will need to comply with the new conflict of interest obligation, which is designed to:

  • “Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest;
  • “Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products [products sponsored by the firm], from causing the firm or its financial professional to place their interest or the interests of the firm ahead of the retail customer’s interest; and
  • “Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.”

This new best interest standard will evolve over time as it begins to be applied in the real world. We will see how this plays out in the future.

Identify Your Needs

Those approaching or currently in retirement should consider whether they need a different kind of financial professional, based on changing needs. From my perspective as someone who has had experience in both the broker-dealer and registered investment adviser settings, the distinction is pretty clear: Retirees would want a broker for discrete investment recommendations on a transaction-by-transaction basis. Wealthy retirees who need to produce income to cover living expenses and protect and grow capital at the same time would want an investment adviser for ongoing investment management.

Discussion

Ronald McNay from CA (for now) posted over 6 years ago:

A CFP is the only, really safe way to go. Of course, one still needs to do their due diligence, but a CFP is where the odds lie...


Jon from MA posted over 6 years ago:

It is but what’s important is if you need the help of a financial adviser, you understand the tasks and reasons why you need this advisor to execute and counsel over. It’s also paramount that one does due diligence in picking an advisor including compensations. I would also see the hybrid, a broker dealer for picking up the transactions and the advisor at the higher investment level. Tasks are based on customer retirement requirements, services needed and compensation needed and agreed with.


Bud from WA posted over 6 years ago:

When I retired at age 60, healthy, and active, this transition was the one thing that I had not given much thought. And I made some mistakes. One was following some of the retirement advice of financial "experts" who almost unanimously say, "Draw down your taxable accounts first, thus giving the tax deferred accounts a chance to run." Well, that ain't necessarily so. One needs to make sure that all decisions, even what we may think is obvious, such as this, match their individual situation. In my case, I would have been better off taking some of my traditional IRA withdrawals earlier and letting my taxable accounts grow because of the capital gains treatment of the taxable holdings versus the fully taxed IRA withdrawals.


DEM from AZ posted over 6 years ago:

I agree that retirees need different advice than those still working but different advice is not necessarily the same thing as a different kind of advisor, i.e. with a different label. In my working years most of my investing was via my retirement plan and it did not allow much choice. A financial advisor might have been useful but not an investment advisor. They question is what does the advisor (of whatever variety) actually do or more to the point what does the retiree want them to do? After twenty years of retirement and mostly being a DIY amid many recent abrupt changes in the tax laws I felt a need for some advice. Not to pick my investments or "manage" my portfolio but rather someone to talk to. I ended up with a CPA, they didn't really recommend any changes but confirmed (mostly) what I had already done. Unfortunately I don't think that Julie Jason really answered the question she posed. She is mostly arguing with the SEC (and with good reason). She put it all in the context of hiring someone to manage your finances for you.


Bruce Bohannon from IL posted over 6 years ago:

CPA's also have a Certification for a RIA, and Financial Planning etc. Consider a CPA/PFS for your Personal Financial Speciaist. We must also abide by the highest industry standards and our Code of Ethics.


TC from CA posted over 6 years ago:

I'm planning to retire in 2 to 3 years. I do have a CFP that is try to help with my retirement withdraw from our retirement accounts and taxable account. He did a Monte Carlo scenarios and the 4% rule so that we do not run out of money. We went to a brokerage firm where we have our IRA accounts and ask for advise regarding withdraw plan from a retirement expert. Same planning as my CFP. It seem like they have the same template for retirement planning. From what I been reading and hearing from The America College (RICP). These retirement planning professionals such the biggest thing is to address the many risks that retirees will face. Such as, longevity, inflation, sequence of return (market risk) taxation and long term care risks. They recommend finding someone that will draw up income withdraw plan to address all these risks.


John from NE posted over 6 years ago:

It would be useful if AAII would refer readers to previous relevant articles such as William Francavilla,"Advice on Evaluating an Adviser From an Industry Veteran," AAII Journal (September, 2018). I am sure the editorial staff could comb the indices of back issues and contribute other citations. I am like DEM, and have been a DIY investor pre- and post-retirement. At some point I might be willing to pay someone else to run our portfolio when I think the benefits outweigh the costs. Until now I've followed the advice of John Bogle and Burton Malkiel and stuck largely with low or no cost index mutual funds and ETFs.


Rick from IL posted over 6 years ago:

I am close to retirement age and recently noticed a few "classes" offered at our local library pertaining to SS and Medicare. It turned out that these were nothing more than 2 hr advertisements for a local firm that will help select your Medicare plans and they would like to also manage your retirement savings for a mere 2%/yr fee. They will manage your funds as a Fiduciary at one of several national brokers. I didn't waste my time, and I suspect their fee might be negotiable, but the thinly disguised platform and cheerleader type atmosphere simply left a foul taste. When I see things like this I question their definition of fiduciary. The best suggestion I've seen here was the CPA. They can and will act as a fiduciary but if they don't disclose their financial relationships with other firms (which most CPA do have), then they have violated their code of ethics and I doubt that would happen. Their fees will be higher but again probably negotiable.


Jean from AAII posted over 6 years ago:

John from NE: We do run a list of 3 related articles with each online article. However, we did not have the Francavilla article listed as one here, so I added it. To see related articles for any online article, look on the left-hand side of the page, after the table of contents for the issue. Thanks for the suggestion.


Allen from Oklahoma posted over 6 years ago:

As a CPA mulling retirement myself, let me make a couple of suggestions. 1) Simply your financial life. Consolidate accounts when able to do so & try to pick one financial house to do business with. Sometimes this might not be possible, but try to keep no more than 2 or 3 firms to hold your assets. If all you do is online, then I'd say pick the best one. 2) As you get older & relinquish more & more control, I'd go with a firm that has a local presence & a dedicated person that you can visit with as needed. This becomes more important if a health issue renders you unable to make informed decisions. Online account providers have delayed customer service response times & no dedicated reps to help you 3). Get your spouse and/or children involved. If you have a durable POA prepared, get it on file NOW with those firms or firm. Whoever you grant this power to does not even have to know that it is already on file. They simply step into your shoes at the appropriate time. 4). Make sure a list of user names, passwords & security question answers is available & someone in charge can find that list !! 5). Make your wishes known even if not in a formal doc such as will or trust. These are just a few things I've learned having to step into my father's shoes after he had a stroke. My comments have strayed from the subject of this article but I feel these are issues that one needs to consider. Personally, I do my own investing & find that financial reps do not do me much good so I am predominantly online, but I do have 2 other local accounts with a dedicated financial rep who knows me & I can access via a local phone #.


Len from NY posted over 6 years ago:

Good point Bud!


Andrea from MA posted over 6 years ago:

I see no reason to deal with a broker-dealer - the fact that they resist being fiduciaries like CFPs and RIAs (and are happy with the hair-splitting and likely evasive Regulation Best Interest) says it all. To me the choice is not between a broker-dealer and a fiduciary, but between someone who understands and focuses on accumulation of assets (i.e., investing for retirement) and someone who understands and focuses on maintaining the longevity of a portfolio during decumulation/distribution IN retirement. The latter is a relatively new area of serious study for financial advisors. The issues to consider in the two phases are very different, which is often misunderstood - or ignored. If you read Wade Pfau’s books (which I highly recommend), he clarifies that the 4% rule is probably outdated in a number of ways (and at best left a 10% chance your portfolio would die before you do), and that Modern Portfolio Theory (which my last advisor professed to follow) was never even intended for the situation of individual retail investors! It’s largely irrelevant to “decumulators,” too. I can’t do Pfau’s latest work justice here - but he certainly clarified a lot for me. Before you commit to an advisor, it’s worth preparing yourself with his take on the matter of income in retirement, and how it can be managed.


Katherine M from USA posted over 4 years ago:

How old is this article?? Why does AAII not disclose article dates on articles?


JEAN H from IL posted over 4 years ago:

Katherine, This article was published in the January 2020 issue, as shown at the top of the article, above the title. Thanks for your interest.


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