The topic of this week’s conversation picks up from last week’s entry regarding the 401(k) Plan Providers you should consider when setting up a retirement plan or evaluating a plan’s current providers.  Now, this stuff can be pretty boring but this entry should finally start building your industry knowledge and make things a little more interesting.
The final provider you should consider for your retirement plan evaluation is the Financial Professional. Unfortunately, the world of finance is shroud in industry jargon which only makes things more confusing and our jobs more difficult. Although most people use terms like Brokers and Advisors interchangeably, their roles are actually very different and their titles dictate how they would support your plan as well as their compensation.  So let’s look under the hood and see what’s really going on.

Let’s start with Brokers. When interviewing a Broker, you should know how they would support your team and how they get paid. Let’s start with the latter. A Broker gets paid by the fund companies as a result of the investment fees the fund companies charge which directly effects Plan Participants. If you don’t already know this, mutual funds are the most popular investment option in 401(k) Plans. The mutual fund managers charge a fee to the investor (also known as an expense ratio) to account for the fund company’s expenses, profits, the broker’s commission, and plan costs. These fees are taken out of the mutual fund’s performance/returns before being passed on to the investor. Most Plan Participants are under the impression that there is no cost to participate in their company’s 401(k) but this generally isn’t the case due to these investment fees. If you didn’t already guess it, a Broker can suggest higher-fee mutual funds to increase their compensation. Many times, the Broker doesn’t disclose their rate of compensation as it’s padded into the mutual fund expenses so the Plan Sponsor and Plan Participants are unaware that some of these fees even exist. That’s why we’re here – to pull back the curtain.
Now that you understand how mutual fund fees work, let’s take a look at how this affects your relationship with a Broker. Brokers can be limited in the mutual funds they may recommend for their clients’ plans. Since they can only get compensated on investments that have the Broker’s compensation baked into the fund, there are certain investments that they may not necessarily recommend. For example, if the Broker wishes to charge a commission of .50%, they would generally only recommend fund options that have an expense ratio of more than .50% to pay for their compensation plus the fund manager’s fees. Since many index funds, institutional funds, and lower-fee fund options charge an expense ratio quite a bit lower than the .50% the Broker requires in compensation (in this example), they would not typically endorse these investments for their clients as there is no commission for them in these fund options. Again, this is a situation where the Broker is limited in what they would recommend to their clients based on how they get paid.

Finally, and possibly most importantly, a Broker rarely serves as a Fiduciary to your plan. If you aren’t familiar with this term, you should start getting comfortable with it as this concept will steer much of your decision-making process within the retirement plan evaluation. There are many definitions of a Fiduciary but the one I like the best for retirement plans is “a person who acts on behalf of another person or persons, putting the Plan Participants' interests ahead of their own. Being a Fiduciary requires being both legally and ethically responsible to act in the plan participants’ best interests.” Since Brokers typically don’t serve as Fiduciaries, they generally aren’t legally bound to doing what’s in the participants’ best interests first and all other parties’ interests second (including their own). You can see how this can present a potential conflict-of-interests without the client having legal recourse toward the Broker.

Based on the above, I recommend interviewing exclusively Fee-based Fiduciary Advisors for your retirement plan evaluation so the Plan Sponsor, the Plan Participants, and the Fee-based Fiduciary Advisor are all sitting on the same side of the table and your interests are aligned. Join me for next week’s class when we discuss the role of a Fiduciary Advisor and how they differ from the role of a Broker. 

As always, I’m here for questions between classes so let me know how I can help…



Investment Fees How Plans are Billed