As a retired person, you should be watching the cost of everything, especially your investments. These costs are often the difference between making and losing money.
But knowing if you are paying too much is a lot more difficult than it might appear.
The newest way banks have found to squeeze more money from their brokerage clients?
It’s called “guided architecture.” Not only is it one of the most expensive ways to invest, but it also puts the interests of the broker and the firm before the client.
[ad#Google Adsense 336×280-IA]This architecture is so full of conflicts of interest, it should be illegal.
But it isn’t!
Now, open architecture is where an advisor guides its clients through money managers and mutual funds that all pay it about the same amount of money to recommend them. S
o there is no motivation to recommend one over another unless it is the most suitable for meeting the client’s needs, matching his or her risk tolerance or making money for the client.
That’s how it should be done. But, here comes the “but.”
A proprietary fund is one that is managed and owned by the same folks who sell it. This is what guided architecture is designed to do… guide you to its proprietary fund. It not only pays the banks’ advisors more to recommend it, but it also makes a whole lot more money for the banks than any independent mutual fund can (American, Putnam, any fund not owned by a bank or brokerage).
And it isn’t just banks that do this.
At the brokerage where I worked in the 1990s, brokers were paid almost three times as much to sell the firm’s proprietary funds as an independent fund.
In case you were wondering, no, I did not recommend our funds. In fact, I had a private meeting with my manager, at his request, to find out why I wouldn’t recommend them. I was one of the stars at the time and it didn’t look good for one of their up-and-comers to not recommend the in-house proprietary funds.
Needless to say, he did not like my answers. And my days at the brokerage went downhill rapidly after that meeting.
But banks and brokerages have always been allowed to guide their clients to their proprietary funds and money managers. Despite the fancy new name, it is still expensive and an outrage!
Here’s how bad it has gotten.
There are no norms or regulations to protect clients from guided architecture, regardless of the conflicts. Mutual fund companies have more protection than clients.
JPMorgan was recently fined $373 million… not because recommending its own mutual funds wasn’t in the best interests of its clients, though it probably wasn’t… but because it broke a deal with an independent mutual fund to push the fund’s products.
The SEC recently stated that recommending a proprietary money manager for a retirement fund might be – not isn’t, might be – a conflict. So we may get some protection for retirement accounts. But there is none even on the horizon for taxable accounts.
These higher payouts for the brokers and the higher revenues they produce for the banks and brokerages are a huge red flag that cannot be ignored.
Staying Afloat
At this point, any rational person should be asking how, in this age of discount, online, cheap brokerages, a system as rife with conflicts as proprietary funds, and as expensive, can still be afloat.
Here’s why.
Back in the early 1990s, CD rates dropped from their crazy 1980s levels – 10% to as much as 18% a year – to 6% and 7%. But no one wanted a paltry 7% on their money.
Please try not to cry or scream about that one.
We, the brokers of the world, were doing a great job of getting banks’ customers to invest their maturing CD money in utilities, dividend-paying stocks, mutual funds and bonds, where they were earning 12% and more a year.
We got so good at it that the banks finally screamed uncle and hired their own teams of advisors.
These new bank advisors sat in bank lobbies. And when anyone had a CD maturing, the tellers immediately sent them to one of the banks’ brokers, located just across the aisle from the tellers.
This was a closed-loop system that played on everyone’s trust of banks – back then at least – and almost always ended with the word annuity. In my experience, virtually every bank broker sold annuities at the highest commissions allowed by law… 6% to 8% was not unusual.
Don’t get me wrong, I like some annuities and they have their place. But the way these were being sold back then was nothing short of stealing. Between the sky-high commissions and the surrender fees no one really understood, the average guy got soaked.
Even more outrageous was the fact that as long as the annuity document explained what the costs and surrender terms were, the broker was covered. He didn’t have to say a word about the costs. Unfortunately, you needed a law degree to figure out what those costs were.
I’m not kidding. In all the years I have been in this business, I still can’t tell you what the total costs are.
And it was so easy for all the maturing CD money to move from an FDIC-guaranteed CD to an annuity. Because, despite the fact that we stock and bond brokers could go to jail for using the word “guaranteed,” by law, annuity salesmen were allowed to say guaranteed. And use it they did.
But as interest rates started dropping, return rates on annuities started to drop as well and the annuity free ride was slowing. The hot new kid in town was now mutual funds. And they tore up the money world.
So the banks had to come up with a way to compete with the crazy returns mutual funds were earning in the 1990s… 15% a year was not unusual.
Which brings us to the current day…
Banks still have brokers in their lobbies and they still try to keep the maturing CD money in the banks. But now, the product du jour, the one-size-fits-all investment, is the banks’ proprietary mutual funds: the ones only they can sell.
They still play on the safety and stability of banks. And as long as the broker gives the client a copy of the prospectus that fully describes costs and fees, which are within legal limits, they are covered.
But the biggest reasons these funds are still in existence is because most investors trust their banks and few, if any, know the right questions to ask.
I can’t say every proprietary fund is overpriced. Although in my experience, they are.
I can’t say that all brokers and advisors who recommend them do it for the higher payout or because it is in their best interests. But again, in my experience, those have been the reasons.
And not all proprietary funds underperform. Most do. But not all.
So what I can say is to never invest in any kind of packaged product, mutual fund or annuity, that does not spell out in a clear way how much the one-, five- and 10-year costs per thousand dollars invested are and the surrender charges.
Controlling the cost of your investments can make or break you in retirement. Don’t let the big boys get more than they should. Know your costs and shop around.
— Steve McDonald
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Source: Wealthy Retirement