Investors working with a wealth manager or financial adviser may be satisfied with their returns. But that doesn’t mean they’re getting all they should.
“Many times prospective clients come to us for a second opinion on their investment strategies. We look into their portfolio and see fees the client is paying that they were not aware existed,” says Daniel Roe, CFP, Chief Investment Officer at Budros, Ruhlin & Roe, Inc.
“These can be in a variety of forms, often not well disclosed, particularly in products that are sold for ‘sizzle,’ which actually have little substance when it comes down to it.”
Smart Business spoke with Roe about the fees some advisers may be hiding in your investment portfolio.
Why should investors be wary of advisers who recommend annuities?
If an adviser suggests a variable annuity as an investment, it should sound an alarm. It’s not considered a standard vehicle for high-net-worth investors.
Some annuities may appear similar to stocks, bonds or mutual funds and have some attractive features, such as guaranteed levels of income upon retirement or downside protection from stock market declines. Their high fees, which manifest as commission to the adviser, as well as provisions that often work against the investor, mean stock exposure can be better obtained elsewhere.
There are times when annuities are useful, such as when a high-net-worth investor has no access to a tax-deferred retirement plan, but those applications are rare.
How can mutual funds be of more benefit to advisers than investors?
There are many mutual funds and each fund can be designated as one of many share classes. The only differentiation among the share classes is the underlying expense or fee structure of the fund.
Typically, a letter of the alphabet — A, B or C class, for instance — identifies U.S. stock funds. High-net-worth investors want to avoid most of these and invest instead in institutional class funds, typically called I shares, which have the lowest cost.
Choosing one of the higher fee share classes creates more income for the adviser, because they represent different compensation or commission schemes. Institutional funds don’t have that.
What costs might municipal bonds hide?
High-net-worth investors often have municipal bonds, issued to raise capital for government projects, in their portfolios. While the interest paid on these bonds is tax-free to the investor, they may incur significant costs.
The secret advisers keep is that municipal bonds can be traded like used cars, with wide variations in costs even though the products are identical. Investors mistakenly believe buying a municipal bond is the same as buying stock, which has a publicized, commonly accepted price. They’re unaware of the markups that are made as these bonds are resold.
Municipal bonds are bought in a negotiated market. If your adviser is not negotiating, that’s a problem.
What reason do investors have to be cautious with exchange-traded funds?
Exchange-traded funds (ETFs) have exploded in popularity, but many investors don’t understand they can accrue a lot in added costs if they’re not traded efficiently. There’s a spread between the buy and sell price, so when investing in ETFs be careful you’re not paying too much per transaction.
How can investors be confident an adviser is working in their best interests?
Don’t be afraid to get a second opinion on your investment portfolio, or even find a new adviser. An adviser who is independent, fee-only and is willing to act as your fiduciary is the best way to ensure investment recommendations are sound.
The phrase ‘acting as your fiduciary’ has legal significance that means the adviser is acting without conflict and in the client’s best interest.
Often brokerage statements say explicitly that the adviser will not act as an investor’s fiduciary, which should be troubling. Work with an adviser who will sign a letter stating that in every facet of your business relationship he or she will act as your fiduciary so he or she can never put his or her interests ahead of yours.
Insights Wealth Management is brought to you by Budros, Ruhlin & Roe, Inc.