If you’re a financial advisor reading this. I’m sorry. I’m sorry if you stuff your clients with garbage funds in order to bang them up on fees. I’m on a rant today because one of our MSB Cheat Invest In You members sent in an email over the weekend asking us to educate them on what they’re invested in.
His specific question was:
“I have one of those exotic 25 fund (taxable) managed portfolios which now makes me want to scream. Per your advice, I asked for a correlation analysis and I forwarded you the response. Is this B.S. or what?? Please feel free to comment or use this as an example on your site.”
Don’t mind if I do.
First of all, this person was told they (the advisor) has a “proprietary rating system to select funds, which seeks to identify funds that will outperform going forward.” This was in the email.
Anytime a financial advisor tells you they have a “proprietary screening process” to find the best funds for you, it usually means they ask you your age, risk tolerance, and a few other questions and then slot you in some sort of “sleeve” with a bunch of other managed portfolio clients.
Breaking: There is no “proprietary” process, unless the process involves scanning their database for high fee funds, which is what you’re getting.
Here’s what I found:
This person is invested in 30 “mutual funds” via the “managed portfolio” platform of a very well known brokerage house that you know. It rhymes with mob. Twenty-one of the 30 funds are stock funds, none are low fee funds.
Let’s stop right there. Thirty funds?
There was some cockamamy mixture of domestic stock, international stock, small cap stock, fixed income, and then real assets. The real assets is mostly a TIPS fund (treasury inflation protected securities). Even my grandma knows there’s zero inflation right now, not to mention it’s a PIMCO fund. Does your “proprietary” screening process screen for funds or firms that are hemorrhaging assets and portfolio managers? Guess not.
The most laughable part of this “managed portfolio” is that the there are a ton of “stub” trades. Stub being, investments in funds that are so small, about 1%, that do little for your portfolio. This is another red flag. These position sizes are smoke an mirrors. They won’t the needle one way or the other.
So why would they recommend a bunch of different stock funds (21 of the 30) when you can invest in just a handful of low fee low cost stock funds that give you the same exposure?
Because of the fees. The fewer the funds, the fewer 12b-1 fees the advisor gets to collect. This fee is masked as an “operational” cost but really it’s a sales fee for the financial advisor or broker doing absolutely nothing for you in terms of value add to “sell you” that fund.
Not to mention the excessive “expense ratio” that the underlying fund manager is clipping from you (which the brokerage house is definitely benefitting from one one way or another by directing assets to a respective fund manager).
To recap: 30 funds, all high fee mutual funds, a significant portion charge 12b-1 fees.
Let’s be clear. I’m not opposed to fees. What I am opposed to is creating portfolios for people with excessive high fee funds when you can do the same job with low cost funds. Fees are absolutely necessary. But only if what you’re getting for those fees is a lot better than a cheaper alternative. And in this case, I’m sure they’re not.
The Labor Secretary’s new fiduciary rule is trying to protect investors from the above situation.
The proposed rule would require money managers and advisors who sell financial products to investors to act as “fiduciaries.”
Meaning, they have to put their clients’ interests before their own. Translation: selling high fee funds that offer little extra value to the client, when there is a cheaper alternative, will be a no-no. The rule is intended to protect the person who submitted this email above.
The WSJ reports that it will “kill the comission model for middle-income Americans.” One financial services firm responded by saying this new rule “will be particularly devastating for those with less than $25,000 to invest” because financial advisors will not be able to cater to them.
Here’s why financial advisors don’t like this new rule.
If the firms are not generating fees on commissions, the business model won’t work. Typically if you have a lot of assets, firms charge based on assets invested, but middle-income investors don’t have a lot of assets, so they just charge you in a roundabout way with the fees. High commissions is what enables financial firms to service clients with fewer assets, otherwise they’d go out of business. Which they eventually will, because of this next point.
I ultimately told him that if he is fed up with old school high fee managed portfolios structure he needs to research robo advisors. To make it easy for him, I did suggest he research the robo-advisor platform of the company he currently has his assets with, which by the way, they had not even recommended to him yet (for obvious reasons). You’re welcome Schwab.
Managed portfolios are dead. The cat is out of the bag: there’s limited value add for the high fees they charge. Robos will crush you. Get ready.
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image via flickr