Avoid the Hidden Costs of Investing

How do you make money in the stock market? Well, a good start is to avoid excessive and often hidden brokerage and insurance fees, costs and expenses. If you think that you are working with an independent and objective fiduciary advisor or planner and not a broker, you are likely mistaken, as brokers often use every name to describe their work except the name "broker." Below are common and often hidden, or at least hard to find, costs of investing.

Commissions

Commissions (or loads) are a real and significant drag on a portfolio's performance. Commissions are common with actively managed mutual funds and are often classified as Class A, B or C. These fund designations have nothing to do with the quality of the fund; instead, they merely signify how the a commission will be paid to the broker. For example, Class A funds charge an upfront fee (typically as large as 3.5-5.75 percent. If an investor invests $10,000 in a Class A mutual fund with a broker, the actual amount invested under a typical scenario would be a  mere $9425. What happened to 5.75 percent of your money? It went into the broker's pocket as a commission.

Avoid most actively managed mutual funds

An actively managed fund attempts to time the market and/or identify the "right" stocks. Despite the fact that this is almost always an unsuccessful endeavor over the long term, the investment public is inundated with these funds due to commissions. Actively managed funds may be identified as Class "A," "B" or "C," etc. In addition to the fees associated with these funds, as described above, other challenges abound, such as high turnover. 

Actively managed funds have turnover that is often 125 percent or more per year. Such high turnover creates many serious problems for investors, including but no limited to excessive fees, bid/ask spread or market impact losses, excess avoidable taxes and style drife. Investors should avoid most actively managed funds. Despite the abundant evidence that simple index funds outperform the vast majority of actively managed funds in the long term, actively managed funds continue to be sold due to commissions. This is hardly independent and objective advice.

Avoid most annuities

Annuities are insurance products, not pure investments. As insurance, these products can be extremely expensive with substantial surrender charges (often 6-14 percent or more) lasting several years to cover the outsized commissions paid to brokers. In a typical commission scenario, you buy a $100,000 annuity and your broker makes $10,000 up front. This is hardly independent and objective advice. Don't be fooled, despite what your broker may suggest; ultimately, you pay this commission and not the insurance company.

Insurance companies often entice investors with enhancements or signing bonuses for buying an annuity. That's money for nothing, right? Wrong. Beware as you probably bought yourself a very expensive annuity that you cannot get out of for several years without a substantial penalty and that enhancement or signing bonus is not free when you consider the various annual expenses. It is no gift to you. In addition to such annual charges, there are annual separate account fees with variable and other similar annuities.

Annuities should be highly scrutinized before purchase by a professional not otherwise engaged in selling annuities. Indeed, the Michigan Attorney General issued a "CONSUMER ALERT," in regard to annuities. We highly recommend that anyone contemplating the purchase of an annuity read the Michigan Attorney General's consumer alert which can be found on the AG's website. To be certain, the Michigan AG's office is one in a chorus of governmental agencies issuing consumer alerts or warnings about annuities to the public. FINRA issued an alert regarding equity-index annuities (curiously, FINRA is the federal licensing agency for the very brokers who sell the product that the agency is warning about). In late 2005, the Michigan Office of Services to the Aging issued a warning entitled, "Seniors Beware: Variable Annuities May Not Make Sense For You!" and the SEC began its review to issue warnings on annuities way back in 2000.

A Simple Solution...

A simple solution for most high-net worth investors or those aspiring to be suh is a Fee-Only Advisor (not merely fee-based) with no loads or commissions that serves all clients as a fiduciary and represents the client and not the investment firm. They invest in institutional investments as opposed to retail and possess substantial education, training and experience, not merely industry designations.

We are by no means alone in suggesting such a solution. Indeed, in his well-regarded and top selling book, The Millionaire Mind, Dr. Thomas J. Stanley, Professor and prolific author on the affluent, makes clear that wealthy investors almost always look to investment advisors who are lawyers and/or CPAs and seldom engage financial planners and brokers.

 

Originally published article in Greater Lansing Business Monthly
 
 
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