The media and casual investors intently follow the stories of investment scams and how they devastate the lives of investors and their families. It is understandable of course: a good human interest angle will definitely get the attention of readers!
THE SKIM: As an investor you put money into a fund to gain diversification and professional management. Those are worthy goals and the fund industry is fully capable of delivering on both fronts. The issue that leads to the skim is putting a value on the services you want. In effect the industry has clouded the process on two key fronts by:
- Adding mandatory “advice charges” to many mutual funds, most often through hidden and excessive sales fees being mislabelled as an advice fee.
- Portraying licensed fund sales persons as “Financial Planners”, “Advisors” or some form of Vice President/Director. These titles imply an advice or planning offering often not available.
The net effect, for most investors, is a steady skimming of your investment portfolio in return for little or no advice or planning services. In fact, there is no requirement for a fund salesperson (your planner or advisor based upon their job title) to even talk with an investor in order to justify the skimmed fees for “advice”.
WHAT IS MISSING: At its most basic level, what is missing is the quality professional advice and planning most clients need but cannot identify or articulate without having experienced it. Basics such as a detailed financial plan, an annual review of the Investment Policy Statement, disclosure of material information on changes made in fund management, an assessment of client need versus risk etc.
WHY JOIN ORGANIZED CRIME WHEN YOU CAN GET RICH USING LEGAL SKIMMING TECHNIQUES?
As an ex-banker I was always amazed that bank robbers would risk up to ten years in jail to rob a bank for $300 (average take from a bank robbery these days is quite low) when instead passing bad cheques/cheque fraud could earn you thousands with virtually no risk of jail time. Only a dummy robs a bank using a mask and a gun these days.
Similarly, I cannot understand why fraudsters would go through the hard work and stress of scamming investors (false documents, false statements, a risky paper trail, high risk of being exposed and charged with a crime), when you can legally “skim” investment accounts with fees that add no apparent value and are not required to be disclosed to investors.
What Does Add Up:
Investors pay a number of innocuous sounding fees either directly or indirectly from their investment accounts. Most investors work on a basis of trust and have no clue what dollar amount they are paying nor what they should be receiving for those fees. This is the environment that makes the skim possible and lucrative.
For those who say, well the salespeople have to eat too I will remind you of two things:
1- Front end loaded fees: Salespeople often receive 5% of the invested funds up front from the fund firm. On a $20,000,000 portfolio that is $1 million dollars. The commission is split amongst the 600 or so client accounts of the salesperson and is again a hidden charge. (Investor Economics data suggests the average portfolio for a salesperson in the advice business is just over $20 million)
2- With the skimmed fees we are talking about a forced, concealed payment for a service that is often neither articulated nor delivered to the client.
BEATING THE SKIM: We do not have to be skimmed as fund investors. You have several options to help fix the problem.
1- Set clear expectations with your salesperson for what you expect for the fees you pay.
a. Communication should include monthly updates, and semi-annual conversations as well as at least one face to face meeting every year.
b. Investment information should include an estimate and explanation of all fees paid from your account , performance results versus a set benchmark, and current versus targeted asset allocations.
c. Planning information should include a review of your financial situation, income, expenses, and liquidity needs going forward.
2- Ensure that your salesperson has the capacity to handle your account effectively. A salesperson with 100 clients is more likely to have the capacity for a review than a salesperson with 600 accounts. Ask about support staff but remember support staff is to aid with internal paperwork not to handle client reviews.
3- Purchase low cost mutual funds and you will not have as many worries about skimming. You can purchase funds without embedded advice fees from a number of fund firms and can purchase ETF funds without embedded advice fees as well. Ditching your advisor/salesperson does not ensure you avoid the skim as discount brokers often take the skimmed fees that normally went to the salesperson. That is of course the height of skimming as discount firms are not even licensed to provide any advice to investors.
It is not easy to be a wise investor when the market is such a deceptive place. It truly is a “buyer beware” experience and not a safe place for those who tend to trust without verifying.