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Three Ways to Prove You’re Fulfilling the DOL Best Interests Standard

It’s here. The Department of Labor’s (DOL) fiduciary rule has been finalized, and its intents are clear: “This broad regulatory package aims to require advisers and their firms to give advice that is in the best interest of their customers…” (81 CFR 20947). Advisors must now provide evidence that their advice is “…based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor.” (81 CFR 21007). In other words, advisors need to demonstrate and document that their advice is in concert with the amount of risk their clients want, can handle and need.

We started Nitrogen just a couple hours from the Port of San Francisco, which has always been known for two things: a constant flow of international cargo ships, and challenges caused by the dense, Bay Area fog.

Over a century ago, a series of prominent “leading lights” were installed to guide ships through the narrow passageway now marked by the Golden Gate Bridge. Sailors would approach the bay by keeping a few key lights constantly aligned. These lights provided a clear path for steering the ship to what would otherwise have been a disoriented crew.

As we approach the implementation date of the new fiduciary rule, advisors will be able to use risk alignment in the same way. The marvelous thing about quantifying risk for investors is that certain metrics can act as “leading lights” toward an indisputable arrival at a client’s best interest.

There are three measurements of client risk an advisor must quantify in order to exhibit the best interest standard. If these three lights align, an advisor’s client is irrefutably invested correctly.

1. Measure How Much Risk the Client Wants

Yes, that’s right, measure it. The old-school way of stereotyping investors based on their age simply isn’t working. Many Millennials don’t want to be invested aggressively. Many Baby-boomers are well prepared for retirement and don’t want to be stuck in the slow, conservative portfolio. Even if it were that easy, what do those words even mean? A moderately conservative investor looks different to you than it does to me.

Use a reputable tool and quantify how much downside risk your clients and prospects can stomach. You can’t operate in anyone’s best interest without knowing them beyond their outward appearance.

2. Measure How Much Risk the Client Needs

The amount of risk an investor wants is not always the amount of risk an investor needs in order to reach their goals. Operating in a client’s best interest goes beyond investing them in the way they feel is right.

If an investor wants more risk than they need, that could be okay. Documenting both measurements will allow you to guide them toward the best investing decisions. If an investor needs more risk than they want in order to reach their retirement goals, this will frame a different conversation. An advisor can paint the picture that one simply can’t get from San Francisco to New York in less than a day if they’re afraid to fly. Or worse, don’t have enough time for that kind of trip even if flying! Advisors need the tools to be able to explain why the client’s risk, retirement age or savings goals need to change — before the client invests, not after they’re in trouble.

3. Measure How Much Risk the Client Has in Their Portfolio

It’s incredible how often I see advisors bring prospects into their office and find alignment in the first two measures of risk, only to discover that they’re currently invested far outside of their risk tolerance.

One advisor just told me a story about a prospect named Greg. Greg sought out this advisor in 2013 when the markets were booming. Greg called him and said, “I’ve been a bit nervous. I like my current advisor, I know him well and golf with him often, but my portfolio has been bouncing around quite a bit. I’ve got $2M and I just feel like I have no margin for error.” Naturally, the advisor sits up in his chair and gets pretty excited… until Greg starts to backpedal. “But, you know, I’ve been making tons of money recently, so I’m not ready to make any changes. Let’s just get to know each other and maybe I’ll hire a second advisor one day.”

The advisor scheduled a meeting with Greg and had a conversation about risk. As it turns out, Greg’s measurable risk tolerance was relatively low. Greg also didn’t need to take on an unreasonable amount of risk in order to reach his retirement goals. Then, these two discovered a game-changer: Greg was invested into a very high-risk portfolio.

Needless to say, when Greg saw the potential downside risk of his current portfolio, he turned white in the face and signed the account transfer paperwork immediately. His advisor may have been a great golf partner, but he certainly wasn’t acting in Greg’s best interest.

Greg’s new advisor fulfilled the DOL’s core mandate by documenting alignment between the three measurements of client risk. Advisors who do the same can navigate any amount of fog brought in by the changing landscape of fiduciary compliance.

Aaron Klein is CEO at Nitrogen, the company that invented the Risk Number and empowers advisors to align clients with their portfolios and expectations.

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