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Is Your Financial Adviser Fishing for Fees?

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If he’s recommending these investments, watch out

Is your broker or financial adviser looking out for your financial interests or just his/her own? If you’re encouraged to invest in any high-cost or high-commission financial product, it’s time to consider that question.

Here’s a look at six financial products that are heavily promoted but that send up warning flags…

  • A brokerage firm’s own high-commission mutual funds. Financial advisers and brokers earn big commissions when they sell shares of mutual funds managed by their own companies. A-class shares are particularly lucrative for them because their “loads” (sales commissions), often 3% to 5% or more, are charged up front, so they get the commission almost immediately.

    What to do: Consult an independent mutual fund rating service, such as Morningstar, before agreeing to invest in any house-product fund or high-load fund. If the funds recommended to you are not clearly superior to similar no-load or lower-load funds, ask your adviser to defend his suggestion.

    Whether it is a brokerage’s own fund or not, consider finding a new adviser if yours suggests selling your A-class shares within a few years of his having sold them to you — unless there is a drastic change in the fund’s management or makeup or in your financial needs. There usually are two reasons an adviser would recommend jumping ship so soon after you pay a big fee to get into a fund — either the adviser made a very poor recommendation the first time… or he now hopes to sell you shares of a different fund to earn yet another commission. Either way, this may not be an adviser you can trust.

  • Hedge fund shares and equally risky products. Hedge funds generally are appropriate only for multimillionaires with diversified portfolios and high risk tolerance. If that’s not you, be very suspicious of any investment adviser who suggests that you invest in one that has high fees. He might simply be after the big commissions that hedge funds tend to pay.

    What to do: Steer clear of hedge funds with high fees… commodity speculation funds… and oil and gas exploration funds unless you are an extremely wealthy, sophisticated investor. Find a new financial adviser if any of these are recommended to you, unless you have indicated that you are willing to take big financial risks and can afford to do so.

  • Any investment referred to as “guaranteed” that promises returns greater than those of a conventional bank certificate of deposit (CD). In the financial world, the word guaranteed doesn’t really mean guaranteed — it means “you better read the fine print.” Many so-called investment guarantees actually are quite limited, sometimes to the point of worthlessness. And remember that any guarantee is only as sound as the company offering it.

    Examples: A CD issued in a foreign country or by a non-FDIC-insured bank might be guaranteed by someone, but not by the US government. A “guaranteed annuity” is not guaranteed against the risk that the insurance company issuing it will fail.

    Unfortunately, some advisers and brokers push new and exotic “guaranteed” investments to clients who only want a safe place to park their cash, because these often pay higher commissions than plain CDs.

    What to do:If your adviser recommends an investment that promises a guaranteed return higher than that of a CD, ask about the risks. If the adviser simply says that the investment is “like a CD” or otherwise implies that there is no significant risk… or if the investment product seems complex but the adviser is unwilling or unable to explain how it works in a way that you can understand, find a new adviser.

  • Municipal bonds with high transaction fees. There are plenty of legitimate reasons for a broker to recommend investing in muni bonds — but there’s one not-so-legitimate reason as well. The rules governing the disclosure of markups on municipal bonds are not as strict as those on most other types of securities. A broker is required to tell the client only the gross price that he has been charged. Exorbitant transaction fees might be buried in that price.

    What to do: Ask your adviser or broker how much of a markup you will be charged on your municipal bond transaction, and say that you want this in writing. Anything more than a few hundred dollars is excessive. Charles Schwab (877-563-7818, www.Schwab.com) and eTrade (800-387-2331, https://US.eTrade.com) typically charge $1 per muni bond, with a $250 maximum ($10 minimum), when transactions are made online. If your broker tries to charge you hundreds of dollars more, use this lower price as a negotiating position to get a better deal or look for a different broker.

  • Private placements. Shares in a privately held company not traded on an exchange (or whose trading is restricted temporarily) might be a wonderful investment opportunity… or they might be a wonderful opportunity for your adviser to earn a massive commission at your expense. Financial pros typically earn 10% to 19% for selling such private placements. Private companies are difficult to research, so it’s almost impossible to know for sure which of these motives is behind your adviser’s recommendation.

    What to do:Just say no to private placements unless you trust your adviser totally. Find a new financial adviser if yours fails to mention the big risks inherent in private placements.

  • Stock and bond transactions conducted with the brokerage as the “principal.” Brokerages typically serve as “agent” — meaning middleman — when clients buy or sell shares. When a brokerage instead serves as principal, it is buying or selling shares from its own inventory. Rather than charge a commission in these principal transactions, the broker will add a “markup” to the cost of the shares (or subtract a “markdown” when selling).

    These transactions usually are perfectly legitimate — large brokerage houses have many shares in inventory, and now and then one of them will be appropriate for your portfolio. Unfortunately, to boost their commissions or the brokerage’s profits, some brokers recommend shares from inventory even when they are not the best options for the client. Not only are markups often larger than standard commissions, but the brokerage also gets to decide precisely when the transaction will be processed. If the share price moves over the course of the day, the brokerage easily could choose a price that benefits the brokerage at the client’s expense.

    What to do:Refer back to the transaction confirmation statements you received from your broker on trades recommended by the broker. If a significant percentage — say 20% or more — are principal transactions, tell the broker that this is a concern.

    Helpful:If your transaction confirmations do not make it clear whether the broker served as agent or principal, this detail is likely expressed as a code with an explanation of the code system on the back of the confirmation.

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Source: Dan Brecher, Esq., who has been practicing security and investment banking law in New York City for nearly 40 years. He specializes in claims against brokerage firms and has obtained awards and settlements of more than $100 million for investors. Date: April 15, 2010 Publication: Bottom Line Personal
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Source: Dan Brecher, Esq., who has been practicing security and investment banking law in New York City for nearly 40 years. He specializes in claims against brokerage firms and has obtained awards and settlements of more than $100 million for investors. Date: April 15, 2010 Publication: Bottom Line Personal