You trust your financial adviser to work in your best interests, but do you really know when they are making the right moves with your money? There are a number of things that a financial adviser might do that seem smart on their face, but when you dig a little deeper you’ll realize that they actually are costing you money that you shouldn’t be spending. First, let’s get some terminology clear that many people don’t understand. There is a distinct difference between a financial planner who has a fiduciary duty to put your needs first in the transactions they propose, and a financial adviser or broker who only needs to recommend “suitable” financial products to you. Obviously there is a big difference between a suitable product that will work, and the best product that is for your situation. Understanding the difference between advisers and planners can help you be on the lookout for potential problems in products that are being recommended for you. Read on to find my top 5 mistakes I regularly see when talking to people about what their advisers recommended for them.
- Active Fund Bias
An active fund is a managed mutual fund where the manager takes frequent action to change the underlying investments of the fund based on how they perceive the overall market. A passive index fund is not actively managed and is a grouping of investments in a mutual fund that are meant to mirror a specific type of index, like the S&P 500, or Blue Chip stocks. Typically advisers recommend active funds to their clients because they claim that there is somebody looking out for the health of the fund and this will translate to better returns. However, active funds are much more expensive than passive funds and historically low-fee index funds have actually performed significantly better than active funds over time. If your adviser recommends an active fund over a passive fund, it’s time to start grilling him over how the fee structure is set up and ask for comparisons to passive funds over 3, 5, 10, and 20 year periods to see if it actually makes any sense.
- Rolling Your 401(k) To An IRA When You Shouldn’t
The traditional advice is that you should always roll your 401(k) to an IRA when you leave a job, but there are situations where this isn’t the best idea. Typically when somebody is in the middle of their career and switches jobs they should roll their 401(k) from their old employer into an IRA, which gives them much more flexibility on the investments they choose and the fees they incur on their money. However, if a worker is nearing retirement and switches jobs or is retiring and doesn’t need the 401(k) money right away the best course of action is probably to leave the money alone. When you roll money into an IRA you are probably going to incur fees for the transaction and you won’t get to benefit from the long-term growth and savings in lower cost structures since you’re close to retirement.
- Load Fees
A load fee is basically a percentage of the total amount invested that you pay when you purchase a mutual fund from a broker that is intended to pay for the brokers time in advising you on what funds to choose. Before the Internet came along this would make plenty of sense as most people don’t understand the market or what investments they should use and advisers could help them to make smart decisions. Today there is a wealth of information available through financial magazines, websites, blogs, and other sources that can give you all the tools you need to make decisions on your own and then go to the broker and make specific choices. There are also plenty of no load funds out there that have excellent fee structures and returns that you can choose from so in this day and age it just doesn’t make sense to pay a load fee. Always ask your broker or adviser about load fees and insist on trying to find alternatives to the fund they recommend with no fees or lower fees whenever possible.
- Vague or Confusing Fees
Fees can crush the investment performance of your money and many fees are hidden in long documents that are difficult to read or understand. When you talk to your broker or adviser ask for them to clearly explain all the fees that you are going to pay on the investment they recommend and ask if these are annual fees or one time fees. You might be surprised to find that many investments actually have 1.5%-5% annual fees when you add them all together and if your fund is only giving you 8% returns that is a hefty chunk of change that is going to fees.
- Bad Performance
You’ve probably noticed that most of my tips revolve around fees and how much you are charged for your investment choices. When you get down to it, the higher fees for a fund, the more likely it is that fund offers a larger commission to your broker. Many firms even give bonuses to their brokers for having their clients by certain funds that may not be the best option available for their clients. It’s not unreasonable to ask your broker what his commission is on a fund he recommends for you. They may not always tell you, but it’s worth asking. Paying more in fees is a sure fire way to torpedo your potential earnings so don’t be scared to ask, it’s your money!