I’ve been a little preoccupied this summer handling an SEC audit. Don’t worry, Servo’s not in trouble, I didn’t do anything wrong. :)
Registered Investment Advisors (RIAs) like Servo are regulated by the Securities & Exchange Commission, under the Investment Advisers Act of 1940. Audits are routine, and for your protection. They ensure Servo, like all RIA firms, adheres to its fiduciary obligation to put your best interests first and discloses when they do not. That’s the adviser-client agreement that we have. The Investment Advisory Contract spells out the fiduciary requirement, and it’s also written in Servo’s ADV. That’s part of what an SEC audit is about—ensuring an RIA firm is doing, documenting, and saying the things they’re supposed to.
Not all financial services firms have a fiduciary responsibility to their clients. Brokerage firms, such as Morgan Stanley, Merrill Lynch, Bank of America, Wells Fargo, Edward Jones, the investment division of your local bank, and even the financial associates at Charles Schwab, are NOT held to a fiduciary standard. They are only required to act “suitably.” Don’t sell a cautious 80-year-old looking for conservative growth a Technology mutual fund. They can sell them an income-oriented mutual fund with a high commission, or a commission-based fixed annuity, because the “advisors” at these firms are salespeople, not advisers. The recommendation doesn’t have to be in the client’s best interest; it just has to be “suitable”. It’s a low bar.
Most people still don’t know about the difference between investment advisers with a fiduciary responsibility to their clients and salespeople at brokerage firms just trying to sell stuff for commissions or revenue. Why? Big brokerage firms are the salespeople, but they are also the billion-dollar firms with the advertising and marketing dollars to spend. RIA firms like Servo tend to be smaller firms and rely more on word-of-mouth referrals from existing clients. Investor ignorance is bliss for brokers.
But I didn’t intend this article to be about the virtues of a fiduciary standard or the superiority of the RIA model of financial advice. I agree with those things, but I also think most people take these concepts way too far. They’re a good start, but not even close to being sufficient for the best financial and investing experience possible. And no one admits this. Think you’re doing OK just because you’ve hired an RIA firm? Not even close.
The biggest issue I have with the fiduciary standard of advice for RIA firms is what it doesn’t say. It does not explicitly address how advisers should invest their clients’ money. But if it did, what should it say?
First, it would clearly outline what not to do.
A violation of fiduciary-based investing would be an RIA firm that actively manages—through stock picking and/or market timing (i.e., “tactical management”)—a client’s funds. How can any serious person consider that to be in an investor’s best interests? According to a study from Dimensional Fund Advisors, only 17% of actively-managed stock and bond mutual funds outperformed their benchmark index over the 20 years ended 2024. The other 83% underperformed. 83%! How can it be in someone’s best interest to invest in a way that produces lower returns four out of every five times you do it? A fiduciary standard of investing should start with an indexed approach to investing, buying broad market stock and bond portfolios at low cost, and not paying higher fees for trying to outguess the market.
Another violation occurs when RIA firms engage in long-term retirement and retirement income planning and investing, yet allocate the majority or even most of their clients’ assets to bonds rather than stocks.
In the short run, investment volatility and losses feel like the main risk to avoid, and advisers recommend bond-heavy and alternative-laden (more on this soon) portfolios to address this. But in the long run, it’s inflation you need to worry about. Everything you eventually spend money on tends to get more expensive. And if you haven’t grown your investment portfolio enough in the long run to exceed inflation, your savings will buy less in the future than it does today. Your “purchasing power” will decline. Counterintuitively, the asset classes that have the highest long-term expected returns—stocks, not bonds—are the ones with the most potential for short-term losses. To reduce long-term risks, you have to accept more short-term risks. You have to absorb more temporary losses. No pain, no gain.
A fiduciary standard of investing would recognize stocks and stock-oriented portfolios as more appropriate starting points for investors, with relatively safer bonds being used more sparingly for short-term spending needs under challenging markets. Bond-heavy allocations should be the exception and not the typical recommendation.
A fiduciary-based investing approach should also avoid specific investment categories.
Many RIA firms and financial advisors today say that when it comes to investing, publicly traded stocks and bonds aren’t enough. They don’t give you sufficient diversification. They say you need “alternative” assets like commodities, real estate, cryptocurrencies, managed futures, and private assets like private equity, private bonds, and private real estate. This makes no sense. At the retail level—where RIA firms operate—alternative assets have been unmitigated disasters. High fees, high failure rates, low access or liquidity, low returns, and highly inconsistent results that make them almost impossible to stick with. And for what? Traditional stocks and bonds have a century of evidence of producing very respectable returns as compensation for their short-term volatility. Public stock and bond markets in developed countries are inexpensive, easy to understand, appropriately regulated, and completely liquid and accessible.
Finally, a fiduciary-based investing approach should address which asset classes to own.
It’s not enough for an advisor to say, “I’ll put you in low-cost index ETFs and mutual funds.” What kind of stocks and bonds, exactly? And why?
Over all rolling 10-year periods from 1928-2024, the CRSP 1-10 US Stock Market Index outperformed short-term bonds (5-Year Treasury Notes) by +5.4% per year, and outperformed 83% of the time. But over the same periods, the Dimensional US Small Value Index beat the US Stock Market Index, which is dominated by large growth stocks, by an average of +4.4% per year, and outperformed 79% of the time. If tilting to stocks versus bonds is usually better for long-term (especially multi-generational) investors, then so too is tilting to small value stocks over larger growth stocks within the stock allocation.
Including small value stocks also leads to a more diversified portfolio. During just the 10-year periods where the US Stock Market Index trailed bonds (losing by an average of -3.4%/yr), the average return of small value stocks was +4.7% per year more than the stock index. Owning small value stocks during a bad overall stock decade is often the difference between an acceptable return and a bad one. You can’t have a fiduciary-based investing approach and only invest in large growth stocks, even if you’re an indexer.
Ultimately, I’m happy that a fiduciary standard exists and that it’s clearly outlined in securities law that Registered Investment Advisors must follow. I don’t think it’s enough. There are numerous RIA firms—friendly people and well-meaning—but they aren’t investing their clients’ funds properly, truly in their clients’ best interests, and in line with our understanding of how markets work in the long run. But they are acknowledged to be fiduciaries, just like other firms that adopt a more evidence-based investing approach? They aren’t, even if the SEC doesn’t recognize it. This doesn’t sit well with me. I also believe there’s a growing community responsibility among those who have discovered a more modern approach to investing than traditional active management, outdated indexing, and short-sighted, risk-averse capital preservation allocations. We have a responsibility not to keep what we’ve learned and benefited from a secret. To spread the word. To pay it forward.
That’s in everyone’s best interest.
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Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or additional expenses except where noted. Indexes and mutual funds shown are for illustrative purposes only and may not be the only or any of the funds that Servo clients hold. Servo was not managing client portfolios over the entirety of the periods shown. This content is informational and should not be considered an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.