The Department of Labor fiduciary rule that takes effect April 2017 contains a compensation limitation that is promised to save investors $17 billion in reduced advisor fees each year, but could also reduce advisors’ compensation by thousands of dollars.
Dalbar estimates that if these cuts take place the average advisor will see a $34,000 reduction in compensation. These cuts will affect every advisor who has IRA or ERISA plan clients.
With the threat of such large compensation cuts next year, Dalbar recently revealed a new tool, the DALBAR Compensation Compliance Test.
“Advisors who simply compare compensation to a peer group average are certain to suffer the average loss,” according to Dalbar. “The Dalbar Test is the alternative to this suicidal approach.”
The Dalbar test aims to ensure that each client bears a fair share of the advisor’s cost and profit. Reasonableness is defined as the compensation that covers the costs of doing business, while passing savings on to clients.
“The most meaningful and generally accepted method of assessing the reasonableness of fees is based on the cost of doing business plus a profit,” according to Dalbar. “While this profit-based approach to determining a reasonable fee may be new to financial advisors, it is centuries old and used by virtually every other profession.”
The method adopted by Dalbar is based on the Gartenberg Standard. The Dalbar Test meets the requirement of the fiduciary rule by applying the cost and profit of operating the advisor’s business to each client. According to Dalbar, there will undoubtedly be clients that fall outside the bounds of reasonableness but the devastating effect of cutting compensation based on mere averages is avoided.