Before buying ANY financial product make sure that this product is right for you in terms of your unique, personal financial situation. Financial products are tools and just like your projects around the house you should use the right tool for the job, not the tool that the financial rep wants to sell to you.
Here are three financial products that you should consider avoiding.
Equity-Indexed Annuities are an insurance-based product where the returns are tied to some portion of the performance of an underlying market index such as the S&P 500. They are also called fixed-index insurance products and indexed annuities. Your gains are limited to a portion of what the index gains and there is generally some sort of minimum return to limit (or eliminate) your risk of loss. As you can imagine these were pitched heavily to Baby Boomers and retirees after the last market downturn and are still being sold based upon fear today.
Two problems here are generally high internal expenses and surrender charges that keep you locked in the product for years. Worse yet, these internal expenses can be hard to isolate. If you decide to go ahead with the purchase of an Equity-Indexed Annuity be sure that you understand all of the details including the level of index participation, expenses, surrender charges, and the health of the underlying insurance company. Check out FINRA’s Investor Alert regarding Equity-Indexed Annuities for more cautionary information.
Proprietary Mutual Funds
It is not uncommon for registered reps and brokers to suggest mutual funds from the family run by their employer. In many cases they are incentivized or even required to do so. While some of these funds are perfectly fine, all too often in my experience they are not. Whether via high fees and/or low performance these are often investments to be avoided.
A lawsuit against Ameriprise Financial brought by a group of participants in the company’s retirement plan alleged the company breached its Fiduciary duty by offering a number of the firm’s own funds in the plan and that these funds then paid fees back to Ameriprise and some of its subsidiaries as revenue sharing. The suit was ultimately settled.
JP Morgan also settled a suit by some retail investors over the bank steering clients into their more expensive proprietary funds over those of other families.
Load Mutual Funds
It is important that you understand the ABCs of mutual fund share classes. In the commissioned/fee-based world reps often sell mutual funds that offer compensation to them and to their broker-dealers. A shares charge an up-front commission plus a trailing fee (often a 12b-1) of somewhere in the neighborhood of 0.25% or more.
B shares charge no up-front commissions, but carry an additional back-end load as part of the ongoing expense ratio. This can amount to an addition 0.75% or more added to the fund’s annual expenses. In addition these shares also contain a surrender charge that typically starts at 5% if your sell the fund before the end of the surrender period. B shares have been largely phased out by most fund providers.
C shares typically have a permanent 1% level load added to the fund’s expense ratio and carry a one year surrender period.
These sales loads ultimately reduce the amount of your investment and are an expensive form of advice. Nobody expects financial advisors or any other professional to provide financial advice for free. Unless the person to whom you are paying these pricey loads is providing extraordinary advice, this is a very expensive way to go.
The DOL fiduciary rules
The fiduciary rules introduced by the DOL (Department of Labor) in April of 2016 impose a far greater level of disclosure on financial advisors. The rules require financial advisors to act as fiduciaries when providing advice to clients on their retirement accounts such as IRAs.
The fiduciary rules require advisors to have their client sign a disclosure document for many financial products with sales charges and trailing commissions if used in a retirement account. Load mutual funds and proprietary mutual funds will most likely require a BICE (Best Interest Contract Exemption) disclosure. Additionally Equity-Indexed Annuities were not exempted from these disclosures in the final draft of the rules as they had been in earlier drafts.
It will remain to be seen how the fiduciary rules will impact these three products, both within retirement accounts and overall. As an example, broker Edward Jones recently announced that mutual funds and ETFs will no longer be offered to clients in retirement accounts where commissions are charged.
Before making any financial or investment decision review your specific situation. Consult a fee-only financial advisor if you feel that you need financial advice.
Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.
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