Some investors question whether their financial advisor is really working in their best interest or if they are looking at ways to increase their own paycheques.
When a new client comes to us with their statements, there are many signs that tell me whether their current advisor has acted in their best interest. I've seen a few interesting ones recently and I felt it would be good to share some of the key signs I look for when analyzing a portfolio so that you are able to feel secure that your investments are being managed properly.
One of the first things I look for is deferred sales charge (DSC) or back-end mutual funds in their portfolio. This is a way that many advisors buy funds for their clients which in my opinion is not in the best interest of the client. DSC refers to purchasing mutual funds on a deferred sales charge basis (back-end) where the result is that the broker actually gets a five per cent commission up front to sell it to you this way and you get locked into the fund for up to seven years. The biggest problem we see with this is that a client is not told about the big commission or the locked-in period. They may want to sell that fund earlier than the lock-in period and if they do then there can be massive fees to pay. In fact, there is one large fund company that almost always buys mutual funds this way but also forces you to sell those funds if you want to move your portfolio to another firm, possibly incurring huge fees before you move. This is almost like holding a client hostage in my opinion!
Another sneaky strategy we see quite often with these back-end funds is when advisors take out the annual 10 per cent penalty-free amount from each of the DSC funds already held only to reinvest it into yet another DSC fund so that they receive another five per cent commission! This seems to be very common and again, in my opinion, the advisor is not looking out for the client's best interest but only for the big commission payday.
I have also seen numerous times where clients have been advised to borrow money to invest. This strategy might be appropriate for sophisticated high net worth investors but for the average investor it is definitely playing with fire. You would be surprised how many investors have come to me not knowing how risky this strategy was because it wasn't explained fully to them. Many financial advisors who recommend this strategy also have their own interests at the forefront. When you think about it, a client who walks in with $500,000 and is told to take out a $200,000 loan has just created a much larger account that the advisor is now managing, which in turn creates more fees, especially when we see they are buying DSC funds as I mentioned earlier. The above example would give the advisor an extra $10,000 in commissions from the purchase of the DSC funds.
Lastly, I have seen many investors come to me with their portfolio stuffed with many new issues of structured products, which can have some hefty hidden commissions. An example of a structured product would be an investment that is a principal protected note (PPN) or certain closed-end exchange listed funds (email me for examples), both of which we stay far away from. Many structured products go down in price as soon as they start trading so even if you really like the investment, why not wait to buy it on the market once it starts trading? I believe advisors who do recommend many of these new issues are really interested in that nice hidden commission.
Don't get me wrong, there are many good, honest financial advisors out there. It is just important that investors be able to identify when they are dealing with one that is not using strategies in their best interest and that investors can make an informed decision as to whether they should be shopping for a new financial advisor.
Lori Pinkowski is a senior vice president at Raymond James. She can answer questions at 604-915-Lori or [email protected].
