Lisa couldn’t understand why two of her IRAs hadn’t grown much, especially since we were in the midst of one of the biggest bull markets in history. After her divorce nearly four years ago, she contacted a female financial adviser she knew from a local networking group who specialized in serving divorcees. Lisa needed advice on what to do with the portion of her ex-husband’s retirement assets which were now under her control.
Earlier this year, Lisa asked me to review her account statements. She felt something wasn’t right. Lisa’s adviser had sold her a life insurance policy (which was probably a reasonable decision because at the time of her divorce her children were minors). But then I saw the statement for an annuity which was held in a Traditional IRA. I thought it odd that a woman who at the time was in her late 40’s, had equity in her home, and had consistently generated a positive income as a self-employed professional, would be sold an annuity.
Indexed Annuities Are Complicated and Expensive Investments
Lisa was absolutely right … the IRA account had barely grown even though it was indexed to the S&P 500 and Lisa had been making monthly payments for the past 3½ years. This was in addition to the monthly payments she made to keep her life insurance policy valid. If the annuity was tied to the S&P 500 which had continually hit record highs, why didn’t her account balance reflect that?
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I asked Lisa to explain the terms of the annuity to me. She couldn’t. And after reading the annual statement, I couldn’t decipher it either. With Lisa’s permission, I called the financial adviser who sold her the annuity. Perhaps I wasn’t asking the right questions because her answers left me befuddled. When I still wasn’t satisfied, she said there was nothing more she could do and that Lisa should call the annuity company. So Lisa and I called the annuity company together. I explained to the customer service agent that we were trying to figure out the annualized rate of return for this investment compared to the potential return of other investments.
It’s not like I’m a financial novice. I graduated from the Wharton School of the University of Pennsylvania with an economics degree and finance concentration, wrote an Amazon best-seller on investing, and am a financial adviser with an award-winning firm. Yet even I was confused as the customer service agent, who was very nice and polite, tried to explain why there would be a large surrender charge (over 6 percent) if Lisa wanted to move her money into a different investment. So while Lisa ended up losing money on an annuity that was supposedly low-risk, the S&P 500 index to which the policy was indexed rose 78 percent over that same period. I had to ask … was this a good investment for Lisa, or was it a good investment for her adviser?
In 2010, (a year before Lisa’s adviser had sold the annuity), the Financial Industry Regulatory Authority, or FINRA, issued an investor alert on equity-indexed annuities. The guys at Motley Fool aren’t fans of annuities either. According to this article, the average commission an adviser receives for selling a fixed-index annuity is over 10 percent.
Watch Out for High Mutual Fund Fees and Deferred Sales Loads
I’m told annuities have their place and are suitable for many people. I can accept that. What I found unconscionable, however, was the adviser’s choice of mutual fund for Lisa’s SEP IRA. Ironically, Lisa thought she was doing the right thing by making contributions to the SEP IRA each year with the money she earned from her business. Unfortunately, she was compounding the problem of high fees by continuing to invest in shares of the same mutual fund her adviser had set up.
I researched the details of the mutual fund which had an 80 to 20 percent equity to fixed income allocation. I felt that investment mix was suitable for a working woman Lisa’ age. To my surprise, however, I found the adviser had sold herClass B mutual fund shares which carry a deferred sales load. Instead of getting charged a commission at the front end, Lisa would pay a commission if she sold the shares before a certain number of years. In her case, if she decided to re-allocate her money into a different investment, she would be charged 2 percent of the current balance, even though she had held the fund for nearly four years. So we looked at what would happen if she stayed invested. Unbelievably, the mutual fund carried an annual expense ratio of more than 2 percent, which is nearly three times as high as the expense ratio Lisa paid on similar mutual funds in her Roth IRA (which she selected without the “help” of her adviser).
I couldn’t have found a more perfect example of a Hobson’s choice. Either Lisa sold her shares and kept only 98 percent of her money or she continued to hold them and pay well over 2 percent a year on a fund that other mutual fund companies charge two to four times less. It reminded me of the movie, “127 Hours,” in which James Franco amputates his own arm.
Work with a Financial Adviser Who Has a Fiduciary Duty to Act in Your Best Interest
There are financial advisers on every corner. How do you know which advisers work in your best interest or potentially profit at your expense? As this articlerecommends, you need to ask the following questions:
- How often do you monitor my investments?
- What is your investment philosophy and what strategies do you use?
- How much am I really paying in fees and how are you compensated?
A financial adviser who adheres to the fiduciary standard will answer these questions quickly and confidently. When Lisa inquired about hiring me as her new financial adviser, this is how I answered the questions:
- At least once a month.
- I construct diversified portfolios using individual stocks as well as low-fee ETFs. Depending on your investment objectives, I will purchase ETFs representing various assets classes such as U.S. stocks, international stocks, REITs, MLPs, commodities and bonds. If you want extra income generation or downside protection, I will sell call options against some of your holdings.
- Based on the size of your account, my firm’s fee is 1.5 percent of assets under management. I am compensated by a portion of that fee. Larger accounts are assessed a lower fee. You will also pay for the trade commissions that our custodian assesses when I make trades in your account. I receive no additional compensation based on which securities I select. There are no conflicts of interest and therefore my interests are aligned with yours.
Why Don’t All Financial Advisers Adhere to a Fiduciary Standard?
The Obama Administration is seeking comments on a proposed rule issued by the Labor Department that would require financial professionals to act solely in a client’s best interests when giving advice or selling investments related to retirement accounts. In its February 2015 report, “The Effects of Conflicted Advice on Retirement Benefits,” the President’s Council of Economic Advisers found that conflicted advice leads to lower investment returns. Many financial professionals have no fiduciary duty, even when they call themselves advisers, consultants or specialists.
This proposal would only affect retirement accounts, because financial industry lobbyists have delayed rules that would make all financial professionals adhere to the fiduciary standard when dealing with both retirement and non-retirement accounts. Companies opposed to expanding the fiduciary duty to all financial advisers warn lawmakers and regulators that removing the ability to charge commissions for financial advice will result in consumers with small accounts not being served.
My solution to serving individuals with small accounts is to provide investment education and coaching through my company, The Options Lady. I essentially charge on an hourly basis and sometimes teach group classes. While I don’t offer my coaching clients advice on which securities to buy or sell, I teach them how to make their own decisions. They learn how to open an online brokerage or IRA account; search for stocks and ETFs with low fees or no commissions; read price charts, review analysts’ reports and achieve diversification by considering the risks and returns of various asset classes. I have coached clients with as little as $5,000. If the regulations are implemented, investors without much money will be served by innovative financial advisers like me or automated investment services.
Armies of lobbyists have been trying to delay or kill permutations of these proposed regulations since President Obama signed the Dodd-Frank bill into law in 2010. For the foreseeable future, it’s up to you to protect yourself. So when you interview a financial adviser who charges a transparent fee (typically between 1 and 2 percent), you could very well end up paying lower overall fees, not be penalized for selling an investment that may no longer be appropriate for you, and have confidence that you and your adviser’s interests are aligned