By Chris de Lorimier MBA
Learn more about Chris on NerdWallet’s Ask an Advisor
With the variety of investment opportunities available today, I find it imperative to report my experience at a recent dinner hosted by an alternative investment firm. If you are unfamiliar with alternative investments, think hedge fund, real estate investment trust or other investment not tied to the stock market.
Our firm was invited to be educated on the products offered by this firm, one we hadn’t worked with previously. While we do not sell commission-based products, this group was offering a new, no-commission alternative that we theoretically could offer our clients.
The evening turned into an unexpected lesson on the deceptive informational tactics, high expenses and unnecessary commissions charged by some firms — red flags for which you, the potential client, should ever be on the lookout.
The firm’s president discussed its history and past mergers with other AI firms. He also discussed the commission-based products they offer and introduced this new, no-commission product, touted as being fully liquid and accessible, unlike prior alternative investments.
However, based on the fine print, my colleagues and I knew this claim to be untrue. The fine print said that if more than 5% of the fund was withdrawn in any one quarter, the fund would be frozen and no further withdrawals would be allowed until the next quarter. That doesn’t sound liquid at all, and misinforming the public is the exact wrong thing to do in today’s financial climate. The president’s explanation for this simply did not hold water. What mattered was that they were burying information that is critical to the accessibility of your money.
When discussion turned to commissions, fees and expenses, I was horrified at the amount of money that went right into the firm’s pockets before one dollar was invested. If you put $100,000 in this investment, $7,000 would go directly to your advisor, if he or she were paid on commission. If it were a fee-based arrangement, as at my firm, the $7,000 would go right to the alternative investment firm. You as the investor save nothing.
On top of this horrid 7% commission, the firm imposes fees totaling 4.5% for marketing, operations and other expenses — such as hosting these fancy dinners. So, while you started with $100,000, you’ve just lost $11,500 to fees and commissions.
What about this company’s amazing returns? According to their report, they have been earning an average return of around 11.5% to 14%, with an annual dividend around 5%. Not bad, until you realize how much you lost up front and how much it will cost you each year. That particular no-commission investment will cost you 1.45% in expenses each year to manage! That’s almost 2.5 times the expense of a no-load growth mutual fund.
Using our $100,000 example and paying out $11,500 to fees and commissions, you’re left with $88,500 as your initial investment. Now, let’s be generous and say you received the 14% return minus the 1.45% annual expense. You’ll have made $11,106.75 plus received a $4,425 dividend. You would have had your money tied up for a year, paid almost $13,000 in fees and commissions and now have a little more than the $100,000 you started with. This sounds like a bunch of garbage to me.
Our fee-based firm battles every day with annuity salespeople “guaranteeing” your money for a commission and the alternative firms promising you large returns by not investing in the market. They prey on your fear of the stock market.
Where does this fear come from? Lack of information? Lack of an objective sounding board where you can ask questions? In the entire history of the stock market, the market has never been down over any given 30-year period. That means that in saving for your retirement, avoiding the stock market to avoid volatility is a fool’s idea.
Many big-name firms wrap similar products in fancy paper with their logo on it. Ask your advisor or broker for a detailed breakdown of the fees and expenses you pay. Are they necessary or is there a more cost-effective option to achieve your financial goals? My opinion is that the commissions business must come to an end in order for investors like you to get the objective viewpoint you need.
Fortunately, FINRA is looking to require firms to identify commissions/sales loads on your statements as of the third quarter of 2016; however, this cannot come soon enough. Excessive expenses and charges have to stop to bring trust, understanding and mutually aligned goals back to the client-advisor relationship.
While I’ll forgo any more steak dinners hosted by this particular firm, I’m glad I went to this one; I now more fully understand the expenses and egos that still exist in the financial world. It ignited a fire in me to change the way this industry does business.
Fear does not have to dictate your financial future. Asking questions and getting cost-effective answers is all you need. Remember, if you can’t explain it to your friends and family, you probably shouldn’t be investing in it. Your financial future doesn’t have to cost you a fortune.