Someone told me recently that I was too harsh in my criticisms of the financial services industry. If you read a few of the more egregious examples I’ve seen just in the last few months, you’ll understand why.
A young couple came to me recently that was doing business with a national brokerage firm. The firm had apparently invested their money in a mutual fund “wrap account”. Essentially they picked a few mutual funds, did the initial investments and added a bit more to it in 2010. For what apparently amounted to almost no work most years, they charged the clients somewhere between $10,000 and $20,000 in fees over several years.
This was apparently an example of what is becoming known as “reverse churning”. When brokers made commissions, they used to try and get clients to buy and sell as frequently as possible to generate revenues for the firm and broker. Now that firms are charging a percentage of assets, many just set up the account and let it ride. It’s nice to get paid four and five-digit amounts for doing virtually nothing. This is has become so common that the SEC has now made the practice of reverse churning a target of their inspections.
Another client came to discuss retirement planning. The person the family was using as an advisor worked for a life insurance company, so no surprise that the recommendation included an allocation to 100% life insurance. The insurance broker made an enormous commission on the sale of the insurance, of course. I was reminded of a great phrase recently that says, “When your only tool is a hammer, every solution is a nail.” While life insurance is an important piece of most financial planning engagements, it is insurance. It is not an investment and it is not a retirement plan. While there are never any guarantees in investing, it is highly likely that the clients will end up with 30-50% less than they would from investing in a well-diversified portfolio of stocks and bonds.
I was speaking with an advisor that had just left a firm. The firm owner’s idea of a good investment was to charge each client the typical 1% fee for managing the client’s assets. Not great, but not atypical. Then they tacked on a 0.15% administrative charge for trading. The trading fee wasn’t for transactions, it was to pay the owner’s sons to put the money into a “fund of funds” that charged another 1% to manage the fund of funds, which of course was full of actively managed mutual funds also charging about 1% (although there was an index fund alternative for slightly lower fees). Then the client was expected to pay the transaction fees charged by the custodians. Oh, and by the way, the advisor, already charging the 1% for investment advice also owned the “fund of funds”. That effectively was allowing him to double dip and so he was earning 2% of every client’s assets with total fees somewhere around 3%. I’m guessing this was all properly and legally disclosed somewhere in some document if someone was willing to wade through 48 pages of fine print legalese.
The last example came through a financial news service. A broker had a client that suffered from dementia. The client’s will left his substantial assets in trust to four different charities. Somehow the broker helped the client find a new estate attorney and lo and behold, the client had a magical moment of clarity and left all the assets to the broker rather than the charities. For more on this possibly criminal case – see here: Broker Allegedly Steals $1.5 Million from Client with Dementia
One thing I find interesting. When you read about these stories, they almost always involve people who are “hybrid” broker/advisors that only sometimes have to do what is in their client’s best interest. You rarely read about these kinds of conflicts and practices among people who are pure advisors who always have a fiduciary obligation. It also seems to disproportionately happen to what I call “The 19%”, those with a few hundred thousand to a few million dollars. The rich have too many people watching out for them and the rest don’t have enough money. When you see things like this over and over again, I think I’m exactly the right amount of harsh. Or perhaps not harsh enough.