Monday, March 2, 2009

Can You Trust Your Financial Advisor?

I've seen several blogs and articles recently that have been extremely negative in their portrayal of investment advisors and investment fees. Carly Weeks and Ellen Roseman have had great responses to their recent columns. I tend to agree with a lot of the indictments as 80% of people out there could be getting better advice.

I waded into the scrum and posted one idea that is pretty important to me, full disclosure of fees. I got a lot of heat for it, presumably from advisors who didn't like an "industry insider" spilling the beans. Did I go overboard? Let me know.

One thing that might go a long way to help regulate the Investment Industry is full disclosure of fees.

There are many different ways to be charged for purchasing investments. For investors who buy mutual funds it is imperative to stay away from DSC or “deferred sales charge” funds.

A DSC is a commission paid to the advisor to sell a product. Generally it is about 5% to 7% with a .50% yearly kickback to keep you in the product. Because the fund company has paid a large upfront commission to the advisor it needs to lock you into the fund in order to recoup its expenses. They do this by charging “you” not the advisor if you need to redeem funds or change fund companies. This redemption fee is on a declining scale usually about 7% in year one, declining to 0% over 7 years. If your circumstances change, the fund performs poorly, you need to move and want to change advisors etc… you will have to cough up the dough to escape, not the advisor.

Advisors who sell on a DSC basis usually do so with trickery. Phrases like, “if you remain invested for the long term there are no fees, or “this mutual fund has no fee” are common ways to semi-disclose DSC fees while ensuring you do not understand what you are paying for. Would any reasonable person pay their advisor 5% or 7% upfront to lock them into a product when the same product with no upfront fee is available?

Why do advisors and companies do this? Most advisors are struggling to fund their lifestyle and the large upfront commission helps to keep them in cuff links. The companies like the revenue stream and the locking in of customers. Plus, an advisor who locks in a customer has more time to prospect for new clients. Who cares if the customer calls? The advisor already got paid.
Companies well known for DSC fund sales are Investors Group and Edward Jones. I believe it is a company policy for them to charge DSCs.

The most insidious sales practice is “DSC churning.” Here an advisor switches you into a new fund without waiting for your redemption charges to expire. In this way he can charge you a full 7% commission every few years. Meanwhile you are paying a redemption fee, which might be 5% after two years. This can deplete your funds fast!

The big banks generally do not have DSC fees. They have “no load” or no upfront commission funds. The fund will pay a higher 1% trailer or kickback to the advisor for continued advice, though. This method of sales is much preferred as you can make changes at any time. But, make sure you are in communication with your advisor as you are paying him for advice and support.

My advice to the industry is that we include a full disclosure clause for DSC products. For example, “you have chosen to pay me a 7% upfront fee to lock you into this product. If your circumstances change and you want to get out you will have to pay onerous redemption charges. There is absolutely no reason, other than helping me to pay by BMW lease, why you would choose this option when there is a no upfront fee option available.”

I’m out like insidious sales practices….

West Coast FP

1 comment:

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