“CommonSense InvestSense™”…Account Management

“Don’t gamble. Take all your savings and buy some good stock and
hold it ’til it goes up then sell it. If it don’t go up, don’t buy it.
Will Rogers

If only it were that easy. While no one can guarantee how an investment will perform, there are certain precautions an investor should take to protect their financial security.

1.  Always keep copies of all forms and documents that are filled out and/or signed. Documents have been known to disappear or change when questions come up.

2.  Never sign blank documents, leaving it to someone else to fill the document in.

3.  Never give anyone discretionary control over investment accounts. Abuse of discretion is one of the leading complaints regarding stockbrokers and investment advisors. The potential risks simply outweigh any alleged benefit. If an investor is asked to sign a trading authorization so that a brokerage firm can accept orders from the investor’s broker or advisor, the investor should write “NO DISCRETION” on the form to avoid any confusion as to the power being authorized.

4.  Read all account statements and correspondence received from a brokerage firm, a broker or an advisor. If wrongdoing is going on in an account and is reflected in the account statements or correspondence, failure to promptly notify the brokerage firm and to object to such questionable activity may prevent an investor from recovering any losses resulting from such activity.

5.  Ask questions. Ask the financial adviser whether they will be serving in a fiduciary capacity in advising you or managing your portfolio.  If they indicate that they will be acting in a fiduciary capacity, ask them if they are willing to put that in writing and sign the document.

Ask why certain investments are being recommended. Ask whether a purchase of a recommended investment product would result in a commission for the broker or the advisor making the recommendation and, if so, what the amount of the commission would be. Ask whether the recommended investment product is a proprietary product of the company that the broker or the advisor is affiliated with and, if so, ask whether the broker or the advisor can recommend similar non-proprietary products.

Ask whether the recommended product has ongoing fees and, if so, how much those fees are. Even if an investor is turning the management of their investment account over to a money manager, the investor should continually ask questions in order to protect against losses due to “black box” asset allocation.

6.  Consider all aspects of an investment. Some investors only look at the historical or projected return of an investment before making an investment decision. Investors should always consider factors such as the risk/volatility of an investment, the fees associated with an investment, and the tax aspects of an investment. This is particularly true when considering the purchase of an annuity. (See “Common Sense InvestSense…Variable Annuities”) Calculate the Active Management Value Ratio on all investment recommendations before you actually invest in order to ensure that your investments are cost efficient.

7. Avoid “closet index” funds. Closet index funds are actively managed mutual funds that closely track the performance of their underlying market index, thus their designation as “index huggers.” The problem with closet index funds is that you basically get the same return as with a typical index fund, but at a much higher cost, often 300-400 percent higher than the index fund’s annual fee. Since each additional 1 percent in fee and other costs reduce an investor’s end return by approximately 17 percent over a twenty year period, closet index funds are an imprudent investment choice.

7.  Be alert to brokers and advisors possibly “working their book.” When business is slow, brokers and advisors may be advised to “work their book.” This may explain unexpected phone calls suggesting that an investor review their investment portfolio and reallocate their assets, switch mutual funds to buy funds from a different fund family, or perform an annuity exchange.

It is illegal for a broker or an investment advisor to make investment recommendations for the purpose of generating commissions. Certain practices should raise red flags for investors. Recommendations that an investor sell funds of one mutual fund company and buy the same or similar type funds of another mutual fund company should be questioned. Recommendations that an investor sell funds of one mutual fund company and buy different types of funds from another mutual fund company should be questioned if the original mutual fund company offers the same or similar type funds as those being recommended, as most mutual fund companies allow an investor to make internal fund exchanges without incurring new commissions.

Recommendations that an investor exchange one annuity for another annuity should always be questioned since the exchange will result in new commissions for the broker or the advisor. Recommending that an annuity owner exchange annuities is especially suspicious when the current annuity is still subject to surrender charges, as the client would lose money as a result of having to pay surrender charges for the exchange. An investor who becomes aware of such practices should promptly notify the appropriate regulatory organizations.

8.  Use breakpoints, when possible, to reduce the commissions on mutual fund purchases. Most mutual fund companies offer investors a discount on front-end sales charges once an investor has invested a certain amount of money in their mutual funds. Most mutual funds begin to offer such discounts once an investor has invested a cumulative total of $50,000 in their funds, with additional discounts for certain levels of additional investments. Recommendations spreading investments among a multitude of asset classes may be cause for questioning, especially when large amounts of money are being invested and/or the recommended amounts are just below breakpoint levels.

9.  Choose appropriate classes of mutual fund shares to reduce expenses. In most cases, A shares and B shares are the only type of mutual fund shares most investors should consider. Many investors immediately lean toward B shares since they do not require the investor to pay front-end sales charges, or commissions. B shares, however, may not be the best choice for the long-term investor due to the higher annual fees associated with B shares.

Generally speaking, A shares are often a better deal for a long term investor due to the fact that annual fees for A shares are typically less than the annual fees charged by B shares. If an investor has a large amount of money to invest, A shares often offer breakpoints to reduce any applicable sales charges. Breakpoints are not generally offered on B shares. B shares are often a better deal for short term investors, since B shares do not impose a front-end sales charge.

While B shares generally carry higher annual fees and often impose deferred sales charges if an investor redeems the shares within a specified period of time, the holding period during which deferred sales charge are applicable is usually relatively short. The investor’s ability to redeem B shares without penalty within a short period of time also allows the investor to minimize the effect of the higher annual fees of the B shares. Some mutual fund companies offer to convert B shares into A shares after a certain period of time has elapsed. Each investor must evaluate their own situation to determine the choice that is best for them.

Investors with managed accounts should always check to see whether their advisor is using A shares or B shares in the management of their account. In most cases, it is generally agreed that advisors should only use A shares in managed accounts due to the lower annual fees charged by A shares and the fact that most mutual funds offer to waive sales charges for A shares held in managed accounts. Another factor favoring the choice of A shares over B shares in managed accounts is the deferred sales charges on B shares. Since managed accounts often involve frequent reallocations of the account’s assets, holding B shares in a managed account may ensure that the value of the investor’s account is reduced by the payment of deferred sales charges.

If your financial adviser recommends C shares, walk away, as your financial adviser is putting their financial self-interests ahead of your best interests. C shares are essentially the same mutual fund as A and B shares. The difference is that C shares typically charge investors an annual 12b-1 fee of 1 percent or more.

12b-1 fees are charges that funds typically charge for a financial advisors ongoing serving of an account and for the fund’s marketing services. As a former compliance director, I can personally state that C shares  are nothing more than an attempt by unethical financial advisors by avoid registration as an investment adviser and the strict fiduciary standard impose on investment advisers, namely to always put an investor’s best interests ahead of the financial advisor’s financial interests. Evidence of that is the fact that the 1 percent 12b-1 fee charged by funds is the standard fee charged by investment advisory firms.

10.   Don’t be lulled into a false sense of security by an advisor’s credentials or designations. The number of letters after an advisor’s name does not ensure the skill or the integrity of the advisor. The most widely respected and recognized designation in the financial planning industry is the CFP® designation conferred by the CFP Board of Standards. The CFP® designation signifies that an individual has a certain level of experience in financial planning, has completed an extensive examination, and has complied with continuing education requirements.

Always ask for both Parts I and II, and all schedules, especially Schedule F, of an investment advisor’s Form ADV. Take the time to read the material to find out about the planner’s background and qualifications. Although registered investment advisors are allowed to use a disclosure brochure instead of their Form ADV, insist on the investment advisor’s Form ADV. Most disclosure brochures are nothing more than glorified marketing brochures, while the Form ADV contains the information the investment advisor filed with regulatory officials. Also check the planner’s records at FINRA’s web site (www.finra.org).

11.   Get more than one opinion. Medical patients are often advised to get a second opinion on major medical decisions. Decisions affecting one’s financial security are equally important. Unsuitable investment advice can drastically affect one’s life. Unfortunately, some people holding themselves out as financial planners and investment advisors may be more interested in selling insurance and investment products than in the quality of the financial advice they are providing.

12.  Avoid the variable annuity trap. Without question, variable annuities are one of the most over-hyped, most oversold, and least understood investment products. FINRA and the SEC are investigating various complaints regarding the sale of these investment products and have already imposed sanctions in some cases. The high fees and expenses associated with variable annuities, along with their lack of liquidity and their negative tax aspects, make them an unwise investment choice for most investors. Annuities can also have devastating effect on an investor’s estate plan, resulting in most of the investor’s money going to the company issuing the annuity rather than the investor’s heirs and loved ones.

13.  Don’t buy life insurance for investment purposes. A popular mantra among insurance agents is that variable life insurance is the “swiss army knife of financial planning.” Anyone who hears such advice should look for another financial adviser. If an investor needs life insurance, then they should buy life insurance that guarantees the amount of protection they need, which is the intended purpose of insurance.

Life insurance is neither intended for or appropriate for investment purposes. The high fees and expenses associated with insurance are totally inconsistent with one of the basic tenets of investing, namely to minimize loss of principal so as to maximize the amount of money working for the investor. While it is illegal for an insurance agent to misrepresent the nature of an insurance product, recent cases involving the alleged misrepresentation of life insurance as retirement/ investment programs demonstrate the need for investors to get advice from more than one investment advisor to better protect their interests.

© 2016 InvestSense, LLC. All rights reserved.

This article is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

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