When it costs you to be a fiduciary

If you’re a true fiduciary, it should be tough at times. You’ll sometimes need to make decisions that are best for your client but rough on your wallet.

Take, for example, the situation of these clients of mine. At the depths of a down market, this couple in their mid-70s put their life savings in indexed annuities and for the next 10 years watched the market run up while their annuity returns lagged. Unhappy with this situation, they sought me out for a second opinion. As we talked about their goals, they explained that they did not need the funds for living expenses and wanted to leave the majority of their assets to their heirs. However, my clients did want access to their money in case of unforeseen expenses. So we unwound the annuities and invested the proceeds into a conservative portfolio.

But my clients weren’t used to market movements. They loved increases to their account balances but were unhappy when the market went down. In our time together, none of the market movements have been out of the ordinary. Still, they panicked.

One phone call in particular had me questioning their whole approach.

“Dave, I can’t do this anymore,” my client said. “Our money is disappearing and we won’t have any left for our kids. We HAVE to do something.”

I listened to the couple air their frustrations, knowing there wasn’t much any of us could have done to prevent them. My clients brought up getting more conservative in their investments and even putting everything in cash. I reassured them that this movement in their portfolio was normal. We had all the typical discussions — that markets will go up and down and long-term investing requires patience. But when emotions take over, those realities don’t penetrate.

I could see the conversation wasn’t helping. When we finished, I took another look at the portfolio. As I examined their holistic portfolio across three accounts, I realized I neglected to take into consideration where they had come from in transitioning to where they were now. One of the current accounts was more aggressive than another and my clients were fixated on how far this account had moved from its original balance.

By contrast, their annuities had moved in the same way even though the balances were different. I sought to see if this difference was the underlying issue. I asked my clients if they would like their accounts to all have the same portfolio design. It would no longer be at a holistic allocation — each account would be the same and move in lock step with each other. I explained that the accounts still could lose value, but this approach —where no account would be more aggressive than another — seemed to allay their fears.

Until, that is, their account balances dropped a couple more percentage points over the following weeks. We then had a more in-depth discussion about how their money was ultimately going to be used. Their priorities hadn’t changed: They still wanted a legacy for their children, but also needed their assets to be liquid so they could use funds while they were alive. I asked them again if they were comfortable losing money in the short-term. Upon reflection and seeing what had happened to their accounts recently, they both said “No.”

This is where being a fiduciary gets tougher. I put a drastic allocation change on the table. I told them if they wanted a portfolio that’s liquid, keeps up with inflation and has minimal risk of losing money, they should be 100% in TIPS. It would limit the downside risk but severely limit their upside to grow their investments. This approach concerned everyone. My clients knew they were acting emotionally. I thought the approach might make my clients more comfortable with their investments, but I also knew that my compensation would now have zero room to grow.

While my clients were taking some time to think the potential change through, I shared the situation with a longtime friend and colleague who is an insurance broker. He suggested that since the assets were split between taxable and retirement accounts and legacy was the main goal, buying life insurance policies with the taxable portion might be a good option. I looked at him with a raised eyebrow: After all, he would get paid if I referred him business. But his suggestion made sense. My clients would still have investable assets in IRAs to meet living expenses and they could transfer the risk of providing for their children onto an insurance company. It was also a move that would lose me money. I was now entering the hardest level of being a fiduciary.

With some rough insurance proposals, I presented the idea to them. Why not split their assets down the middle — ensure the legacy portion and still keep money liquid? They saw the benefit in this approach but they didn’t want to get back into bed with an insurance company. They had faith in the market over the long-term and knew that while they kept all the risk they also stood to gain all the reward.

I also explained to them how I had a conflict of interest here. If they took the money and invested in insurance policies, I would lose money. By abiding by a fiduciary oath, I was now in a situation where I stood to lose from a client’s action. But that’s what I signed up for. Clients’ interests will always come first.

Insurance registered advisers might say it doesn’t have to be that way. But I don’t want my clients questioning, “Why is he suggesting an insurance policy if he’s going to get paid on that as well? Does he stand to gain more with the policy he’s suggested versus what we have now?” I’d rather have them understand that I will continually offer suggestions in their best interest even if I lose money doing so.

The client decided to stay with their portfolio. While I would’ve supported them and whatever decision they made, playing the fiduciary game really tested me. But I’d it do again for every client that I work with.