You're Getting Robbed

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

A Note From the Editorial Director: We received a question recently from a regular Investment U reader on a subject that comes up too often: The costs he's paying his broker. He writes:

"I recently had a very frustrating conversation with my broker. I wanted to know how much I'm paying in fees and commissions to work with him. And I couldn't get a straight answer! I still don't have it sorted out. Is this a common experience? Should I fire him?"

I'll have more to say on broker fees in this week's Oxford Insight, our newsletter for Oxford Club Members. But this question also called to mind something Alex wrote on this very subject last summer. Every word is still true, and it's clearly time for a refresher. If you're using a full-service broker, pay attention.

- Andrew Snyder


You don't know how much you're paying in investment costs. (I'll explain why in a moment.) But if you are using a full-service broker or insurance agent, it's almost certainly way too much.

Take mutual funds, for instance.

Broker-sold funds don't just have front-end and back-end loads (commissions), they also come with 12b-1 fees attached. For the uninitiated, that's additional compensation paid annually to the broker who sold you the fund.

On top of loads and 12b-1 fees, each fund charges management and administrative fees and has to cover security spreads and trading costs. High costs are just one of the many reasons that more than 95% of actively managed funds can't beat an unmanaged index fund over the long haul.

You can't find shelter in broker-sold index funds, either.

Unless it's an exchange-traded fund (ETF), it almost certainly has much higher costs than ones offered by big no-load families like Fidelity, Vanguard or Charles Schwab.

Ignorance Is Expensive

Of course, mutual funds and their high fees are only one of the ways you're paying through the nose. There are expensive whole-life policies (which I covered in this column), annuities with their high mortality expenses and surrender penalties, stock-trading commissions, annual wrap fees, and so on.

In a recent op-ed piece in The Wall Street Journal, Burton Malkiel noted that from 1980 to 2006, the U.S. financial services sector grew from 4.9% to 8.3% of GDP.

Most of that jump represented increases in asset-management fees. Yet even though most clients get no performance advantage from these higher fees - quite the opposite, in fact - few complain for a simple reason.

They don't know how much they're paying.

Don't get me wrong. The SEC requires disclosure of investment costs. But the fees are buried inside of legal forms, account opening documents and inch-thick prospectuses.

Bleeding Out

For example, my father-in-law Tony used an investment advisor who recommended an expensive family limited partnership and filled it with broker-sold investment products. I asked Tony if he had any idea what this was costing him.

He shrugged his shoulders.

"Ask him," I said. "I'll lay serious odds that you never get a hard number."

He disagreed. He said his advisor was a good guy and that he'd get the information.

But he didn't. His broker's response to the first inquiry was a gentle brush-off. "Tony, don't worry. I'm taking good care of you here."

A further push for a written accounting of total expenses paid netted a more forceful response. "Tony, your costs are reasonable. I'm doing a good job for you. What's the problem here?"

The problem, of course, was that Tony was getting bled dry - and he never did find out what he was paying in total costs.

He did know, however, that after more than a decade the partnership still wasn't worth any more than what he started with. Set-up fees, maintenance fees, accounting fees and investment costs were devouring his entire return.

"And the final kick in the ass," said Tony, "was he charged me $60K to liquidate the partnership. The returns I had planned for my kids went entirely to my advisor."

This story is not unusual. Most clients don't ask their advisors for a full accounting of costs. So most advisors don't provide them.

Pay Attention

This doesn't mean your advisor is a bad guy (or gal).

In my experience, most stockbrokers and annuity salesmen are trying to do a good job for their clients. And they have been well trained to explain the benefits of what they offer. (Even if it often means glossing over the drawbacks.)

If your advisor doesn't provide a ready answer for how much you're paying in total costs, it's generally because he has no idea himself. After all, to provide you with a hard number, he'd have to dig out every prospectus for every product, calculate the total costs paid for each, then add them to the trading commissions, loads and wrap fees you're also paying.

If you find this a little surprising, it may be because you're unaware how much pressure your advisor is under to convert a percentage of client assets into firm assets. (Although he or she is well-incentivized and compensated for the task.)

What is the solution? The first, of course, is to manage your money yourself. If you don't feel qualified, you might read my first book, The Gone Fishin' Portfolio, a primer in how to manage your money in a sophisticated way with minimal costs. Pair it with my latest book, An Embarrassment of Riches, which offers a powerful antidote to our culture of negativity and shows you exactly how positive thinking can make you happier and wealthier.

Of course, certain people truly need an investment advisor.

They may be too emotional to effectively handle the market's roller-coaster rides. Some lack a thorough understanding of basic investment concepts. Others are too busy traveling or running a business. And some, quite frankly, just don't want to fool with it.

In this case, you might opt to use a registered investment advisor who charges a reasonable fee and invests through a discounter like Schwab or Fidelity. This prevents you from getting into an adversarial transaction-based relationship.

Whatever path you take, know and understand your investment costs. They may be subtle. They may be hidden. But like termites gnawing away inside an antebellum mansion, they can do enormous damage over time.

Good investing,

Alex

P.S. We want to hear about your own experiences with full-service brokers and other financial advisors. Do you know how much you're paying? Do you think you're getting a good deal? Just click the comment link below to share.

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How to Get Wall Street to Pay You

Sure, the financial services industry has a well-deserved bad reputation when it comes to delivering customer value. But that doesn't mean that individual firms in the sector can't deliver tidy profits to their shareholders.

If any Wall Street haters felt squeamish about following Alex's advice in August - to pick up shares of investment bank Evercore Partners (NYSE: EVR) - perhaps the 16% gain the firm has handed shareholders since then will help them feel better. Evercore is not an advisor to individual investors; it specializes in advising companies on mergers and acquisitions.

Here's what Alex told us about Evercore in September:

"The market heaved a sigh of relief last week - and rallied - when the Fed decided to put off 'tapering' its $85-billion-a-month bond-buying program.

"These bond purchases keep long-term interest rates low, stimulate the economy, and goose the housing market. And for reasons I'll explain, they also keep the merger and acquisition business hopping.

"A good way to play it is with one of our newer recommendations: Evercore Partners (NYSE: EVR).

"Based in New York, Evercore is an independent investment bank that serves clients by avoiding the conflicts of interest inherent to Wall Street's biggest players.

"Roger Altman founded the company in 1996. He is a former executive at Lehman Brothers and Blackstone and was deputy Treasury secretary in the Clinton administration.

"Over the last five years, Evercore has more than doubled its roster of M&A pros. And these guys bring rain. The company has 63 partners. The average senior managing director generates more than $10 million in revenue per year.

"Merger and acquisition activity is likely to surge in the months ahead. Over the last five years, companies have cut costs to the bone, laid off nonessential personnel and refinanced their debts at lower levels. But revenue growth for most of them is still at low- to mid-single-digit levels. In order to boost the top line, they need to make acquisitions.

"Many of them will turn to Evercore.

"Big companies like Goldman Sachs and JPMorgan want to underwrite and trade. That can cloud their vision and divide their loyalties when they dispense advice on deals. Evercore doesn't have those conflicts. That's why it's closed more than $1.3 trillion in mergers, acquisitions, divestitures, restructurings and other strategic transactions.

"It advised railroader Burlington Northern Santa Fe on its sale to Berkshire Hathaway and drug giant Sanofi on its acquisition of Genzyme. AT&T and BlackRock, among many others, turned to Evercore this year for acquisition advice.

"And while the company specializes in media, technology and telecom, it is now diversified across several other industries as well.

"The company's numbers are excellent. In the most recent quarter, earnings more than doubled on a 20% increase in revenue. Operating margins top 18%. And the balance sheet is strong with little debt. I estimate that Evercore will earn $2.25 a share this year and more than $3 in 2014.

"Bear in mind, these great profits were before merger and acquisition activity even heated up. A rising market gives potential acquirers more firepower, as many deals are done all or partially in stock. And as business confidence improves with the economy, more deals are likely to be announced.

"Evercore is expanding internationally, too. It has offices in Mexico, Britain, Brazil and Hong Kong and strategic partners in China, Japan, India, Korea, Russia and Argentina.

"In short this is a premier independent investment bank with superb management, strong fundamentals and excellent growth prospects. You'll earn a 1.8% dividend here, too."

- Bob Keaveney with Alexander Green

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