It is an old adage – Stitch in time.
How relevant it is to the investment industry is a serious thought. It is like the termite, a constant threat to the invaluable home. Unless treated well and square in time, the enormous loss will be incalculable.
The retirement accounts holders, especially. 403(B) accounts need to look into this with due attention when they do not always belong to high net worth clientele and are in a very preferred category of being employees in universities, teaching institutions, churches and many other non-profit organizations.
When their funds are invested, most often they are not necessarily by the investors choice. They go into mutual funds and annuities as a regulatory requirement and cannot be invested direct into equities or bonds. The basics of the types of funds is not part of this discussion. Invariably, the retirement funds are invested only in mutual funds, their financial advisors managing the choice of the fund.
We are concerned about the investment in progress, the red flags and how to counter them either initially or midstream. With this background let us consider the following:
First, the investor has to choose a reliable financial advisor. The advisor may be a fee only or fee based. The difference between the two is the relevance to conflicts of interest. Fee only advisors restrict their compensation to a fixed percentage on the assets under management, say around 1%. The do not cling to commissions or brokerage charges. The fee based advisors are more attached to the fallouts of brokerage commissions, incidental costs and fees, etc. They would prefer to choose such investments where their interests are premier to clients interests. Hence beware the advisor and his/her credentials. Read their information profiles before commitment. The advisor should be backed by professional qualifications, bound by the code of ethics to which they swear and the years of valuable experience in the industry. However, when the plan is managed by an employer, there is limited choice for the investing individual to be aware of the contract. It may be prudent to seek the information from the employer as well since the funds are not employers funds at stake but the investors hard earned wealth.
Secondly, the type of investment chosen have risk levels commensurate with the plan in the funds, whether they are simple indexed, variable or tax preferred and their contractual obligations. Since the investment is planned for long term holdings, the accretion or growth in the investments are dependent on the funds objectives, track record, the management structure, client orientation, etc. Experience has shown that a safe and simple choice will be an index fund tagged to the performance of the bench mark index, where there is no additional cost apart or may be the advisory fees.
Thirdly, the contract should be clearly understood. Look at the projections of the funds in terms of the movement of the investment as to the initial investment and the projected terminal values.
Fourthly, the contract will run into at times hundreds of pages with fine prints. The investor should be aware of the very salient features at least in a comprehensive summary picking all important binding terms on the investor. Briefly these may relate to period of investment, the loads, additional costs and fees, penal provisions, etc.
We will discuss these components individually:
Advisory fees are the charges paid direct to the manager of the funds and is the reasonable component.
There are two types of loads funds. No Load and load based. The no load fund does not charge any costs at any point.
But In contrast, there are funds, often containing nontransparent characteristics. front end load, back end load and 12-b 1 fees.
- The front end load is the immediate punitive load. hidden fee 1. Say, you plan to invest $100,000. With a front end load of 5%, the actual investment will be only 95% or $95,000. The difference of $5,000 is collected upfront before the investment commences by the financial advisor. This may not always be a one off claim and will repeat with every ongoing investment. This load will appear small at every investing stage but the cumulative effect of such charge will be very destructive and show a glaring gap in the expected terminal savings when the contract matures.
- Back end load this is a charge related to the continuance of investment, commencing for a contract of 10 years with 7% charge for the first year withdrawal and reducing year after year until year 7 ending with 1% charge. It may be prudent to accept this charge and exit early if the funds do not outperform continuance. – this is hidden fee 2.
- 12-b 1 fees appears innocuous as if relating to some advertisement s costs, administrative expenses, etc. But this is a charge on the client without any net benefit whatsoever but to promote the sales of the fund at the expense of the client. This is hidden fee 3.
- Wrap fees some times as much as 2% for creating an account for owning a package of managed funds. This is hidden fee 4.
- The list is so long including number of other concocted claims by fund managers totally irrelevant to the interests of the investor.
These hidden fees are a serious drain on the nest egg of the client. Many clients have come up with statements showing a state of the investment balance after say 10 years of holding par below their investment not because of the gyrations in the market. This is wholly the greed factor of tied fee-based financial advisors, at the cost of the unwary client. Instances of claims of even 25% charges are not seen rare.
Claim of past performance creating a feeling of secure source of investment is a misguiding lead to the innocent investor including invitations from known providers unless they are in reputed growth stock funds with impeccable track records.
But the incidence and consequential damages to the wealth is not necessarily on the financial advisors. When there is inattention of the investor or more pronouncedly his confidence that the plan will protect his interest is the occasion when abuse will rear its ugly head. There is a duty cast on the investor as well. This includes timely verification of account statements from advisors, understanding the contents like investment values, costs involved and the reasons for the charges. In case the investor is not in a position to verify the facts, it is strongly advised serious impartial professional guidance should be sought before the drain continues.
The continued hue and cry for a cure to this hidden fee phenomenon and legislation do not seem productive unless the fund advisors disclose their revenues very clearly and openly showing the different components marketing administrative costs and the profits they earn from their transactions. This is a moral responsibility of the fiduciary role of the financial advisors.
Thus ends the tale of stitch in time profoundly relevant to the investor world.
