After spending nearly a decade in the financial services arena, I have literally seen it all.
As much as I would like to tell you all financial advisors do what is in the absolute best interest of the client, that would be a blatant lie.
Often advisors omit, forget, or leave out information so you don’t know exactly know much you are paying in fees and commissions. Though there are pages of disclosures when opening an account, the words you hear the most are sign here.
Even if you were to attempt to understand all the fees in financial products; it would take you days and a doctorate degree to begin to grasp the information a prospectus.
Just to give you an example, below are a few terms most investors have never heard of:
- Cash drag fee
- 12b-1 fees
- Transaction costs
- Front-End Loads
- Back-End Loads
- Mortality & Insurance costs
The only thing most investors see and remember is a nice “long-term” track record of past performance. You have probably seen those pretty portfolios that have defied all odds and outperformed virtually everything.
Just remember hindsight is always 20/20. I too can construct a perfect portfolio by looking back in time.
I want to share with you a few investments that aren’t always fully explained. Hopefully, this article will help you avoid making investment mistakes in the future and re-evaluate your current investments.
Whole Life Insurance
There are two main types of life insurance: Whole Life and Term.
Whole life insurance offers you insurance for your entire life and can create cash value after paying premiums (payments) for years. Typically you pay more for less insurance.
Term insurance offers you life insurance for a specific term (think 10, 15, or 20 years). You get more insurance for less money, but never build up cash value.
I am probably one of the few people who doesn’t think whole life insurance is totally evil. It truly does have its place in the world, just NOT for 99% of the population.
There are two reasons I don’t like it for the majority of people. 1) It’s expensive 2) Most of the time parents can’t get the appropriate amount of insurance to cover their families.
Below is a comparison of a quote I recently received from term and whole life insurance. As you will notice whole life is very expensive.
$1,000,000 Term Policy for 20 Years – $47.49/month
$1,000,000 Whole Life Policy – $734.28/month
$50,000 Whole Life Policy – $73.68/month
You also must wonder about the advisor’s intention because they get paid a lot more for selling whole life. If I were to purchase a million dollar whole life policy, the agent would make nearly $8,000 as opposed to about $280 for selling the term policy.
As you can see, it is much more advantageous for an agent to push the whole life.
If you are being pushed by someone to purchase whole life, then think about getting a second opinion.
I’ll admit – I sold a ton of mutual funds when I was a financial advisor. There is nothing wrong with mutual funds, you just need to understand all of the expenses.
Let’s review the charges in mutual funds:
- A Shares – Have a front end fee of up to 6%
- B Shares – Have a back end fee of up to 5%
- C Shares – Have higher yearly fees
- Management Fee – Fees paid to the people making investment decisions
- 12b-1 Fees – Cost to market and sell the funds. The advisor also gets a portion
- Transaction Costs – Costs incurred in trading
- Cash Drag – The cost of having excess cash in the funds
Often an advisor only mentions a few of these fees, when in reality an investor is paying 3%+ year for many mutual funds.
You need to decide if this 3% is worth it for the returns you will get. Many times you can get better returns investing in a diversified portfolio of ETFs.
If you have ever talked to a financial advisor, especially in the bank, they have probably presented a variable annuity to you.
Although they may appear to be great products, they usually aren’t in your best interest.
A variable annuity is an insurance contract that invests in mutual funds. In addition to the costs of the mutual funds, you will also have the following fees:
Mortality and Expense Charges – This is the cost of insurance and is usually 1-1.5% per year.
Surrender Charges – Depending on the variable annuity, there are surrender charges for up to seven years. This means if you want to get your money out of the annuity, you will have to pay a fee of up to 7%.
Also, when an advisor sells a variable annuity sometimes they earn up to 10% commission on the sale. If you invest $50,000 in a variable annuity, an advisor can earn up to $5,000.
So you think the bank where you have your CD or savings account isn’t charging you anything? HA!
You may not lose any money by having your money in a savings account, but you sure as hell aren’t making money either. Savings accounts, at best, barely keep up with inflation.
The banks are using your money to make money through a number of different activities. Placing your money in a savings account is really just an opportunity cost.
So what are you supposed to do with your money?
It is proven fees play a heavy impact on your investments.
These are robo advisors. They are online management services that provide automated, algorithim-based portfolio advice without the use of financial planners. The fees are substantially lower and the returns are often similar as financial advisors .
Investing is a personal decision. No matter how you invest, make sure you know your fees. These fees will make an impact on your money.