The Securities Industry is governed by several standards. I mention the fiduciary responsibility that you expect when you are put in a position of vulnerability, and this is at the heart of what a fiduciary must consider when recommending any sort of investment. It suggests that you are trusting the experience of someone with more information to do what is right based on a good faith agreement, a belief that your loyalty will be returned when the fiduciary puts your interest before theirs.
Often referred to as the weaker cousin of the fiduciary standard, the suitability standard allows the client to be led to the products that are for the benefit of the person recommending them, such as in compensation for the sale, and may be for the benefit of the person buying them or investing in them.
It is easy to confuse the two and in many instances, we place trust where trust has been relegated to the shadows. This is most suspect when we approach retirement planning. If we ask the questions we are supposed to ask ourselves and anyone doling out advice (specific advice about where to invest, not generalities such as “buy small-cap funds”), we will reveal which standard is applied and when.
For instance, you are told to invest in your 401(k), it is made easy for you to access, it has tax benefits, and in many cases, the incentives such as a company match give you the impression that this is what you should do if you hope to achieve a well-financed retirement. The suitability standard would most likely apply in the situation in part because the plan sponsor will make money from the arrangement, the company will save money from the arrangement and you can benefit as well as long as you participate. If you choose not to, then a no-harm-no-foul situation unfolds. (There is harm in not participating in your 401(k) which is the best alternative most of us have to poverty in retirement but the choice is wholly yours.)
The fiduciary standard applies when the company offers the products to you and in doing so profits from them. If the plan sponsor suggests that the business would do better from a fee management point of view if they offered a certain mix of funds or limited funds to a certain type, they would be violating the trust you placed in them to help you get to retirement. Right?
They may have violated a legal standard but the choices you make, just like all the choices in your life, are yours. How you you use them can be influenced by other, more-smarter-than-you types who appear to be experts or at least have your best interest in mind, but the choice is still yours to make.
And those choices are surprisingly numerous. I have been suggesting that you use your 401(k) in a manner that does not fit with the norm. The axiom “max-it-out” may seem like good advice but what if, as is often case, the plan you have to work with isn’t really much of a plan, with poor choices or simply so many as to make the task doubly difficult? Should you commit $16,500 to a plan that might not be worth your while? Yes and no.
Keep in mind, the 401(k) you have in your workplace is not your only choice. But it probably is your best option. Your 401(k) plan is a tax-deferred option for retirement that allows you to invest now and pay the taxes when you retire on not only the income you use to make the investment but the returns on those choices.
Yet who can say with any certainty this will end up being the best tax solution? Who can say, with any conviction that the tax rate on your current income will be less than the income tax rate you might experience in retirement? Which standard applies?
But as I said earlier, you have choices and using your 401(k) for some of them is important. But for all of your retirement money? if you were to use your 401(k) for up to 6-10% of your pre-tax income, invested in a less tax-efficient way (read: actively managed funds that assume more risk than index funds, target date funds or ETFs) and then looked outside your 401(k) for another investment, you might find that approach more suitable.
Outside of your 401(k), you could open a Roth IRA and in it, buy a tax-efficient investment, one that allows you to invest in taxed dollars in an investment with low-tax implications. This would be a hedge against the possibility that your tax rate will go up, higher than it is right now and if it doesn’t, you are no worse for the method.
Once you max out the Roth IRA, then move back into your 401(k) and if it is possible, max-it-out. Not his sort of employment of these retirement tools gives you more choices in how and where to invest. Yet, most of us will not put 6-10% in our 401(k). And no matter what method we use, which standard we want to apply, under-investing will be the biggest problem we will face in retirement and the hardest to reconcile with the image in the mirror.
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