“What is the most important yield when selling a bond?” my mentor asked during my early days as a registered representative. “Umm, YTW,” I said, referring to “Yield to Worst”, a term that refers to the worst possible yield an investor can expect to earn when they buy a bond. “Nope, it’s YTB!” he said with a wry grin. I tried to play it cool and not betray the fact that in my whole six months of experience I had not learned what the “most important yield” was, so I just nodded my head and smiled.
“Do you know what YTB is?” he asked. I looked up at the ceiling and closed my eyes, thinking back over the previous months of studying to pass the Series 7 and 63 exams. I racked my brain to try to remember if we may have covered it during our sales training program. Finally, I looked him in the eye and said, “I’m sorry, Jim (not his real name), I don’t know.”
“Its yield to BROKER, the only yield you ever need to worry about!” he exclaimed, very proud of himself for teaching me a life lesson. Jim then went on to explain that I should always consider how many points (commission dollars) are built into a bond that I might propose to a client. His rule of thumb was to always stay above 3 points, or $30 per $1000 bond. As long as we could justify that the bond was a “suitable” investment for the client, we were largely protected from client complaints that we didn’t sell them the best bond we could find for them, even though there may be higher yielding bonds available with lower commissions. That, in a nutshell, is the difference between a Suitability standard that most brokers operate under and a Fiduciary standard which all Registered Investment Advisors (RIA) are bound by.
The Fiduciary standard is also sometimes referred to as the Prudent Man Rule, which requires that a fiduciary invest assets as a prudent man would invest his own money in a similar situation. A consumer should be aware that brokers may have incentives that have nothing to do with the client’s best interest. It is at least worth asking if the product you are being offered pays the broker more than other similar products or if there are any incentives like bonuses, trips, Cadillacs, or steak knives that he or she may be in line to win if the sale is made.
If you just want to avoid those potential conflicts, seek out a fiduciary that is bound to act in your best interest. In January, a memo was leaked by the White House to The Hill that suggested that investors give up $8-17 Billion annually in fees and lost performance because of these conflicts. This week, President Obama directed the Department of Labor to move forward with rules that should reduce some of these conflicts on retirement investments. The brokerage industry is pushing back, much as they did in 2010 when a similar proposal died on the vine. (Full disclosure, as Principal at an RIA, these changes could benefit me and my firm.)
Even if these new rules stick there will always be someone out there looking to maximize their YTB. If you, like me, don't necessarily believe that we can or should be shielded from every risk by Uncle Sam, the following tips should help:
1. Don’t be pressured into a quick decision when it comes to investments. Take your time and do your due diligence. Spend at least as much time researching each decision as you did your last refrigerator purchase.
2. Remember that asset allocation accounts for 90%+ of your returns according to some studies. Where your account is invested is much less important than how it is invested. Be especially careful if you are being advised to move money from a 401k or into any insurance product.
3. Get a second opinion (or third, or even fourth) from people you trust. It could be a friend, accountant, financial planner, or anyone that you feel has your best interest at heart. Remember, Caveat Emptor. Be an informed consumer.
There are very few guarantees in the investing world, but if you follow these steps next time you are considering a new investment you should give yourself a good chance to improve your YTY.
Yield to You!