Is Your Broker Robbing You Blind?

During good times, you can make money just by blindly following your broker's advice. Now, though, you may be paying the price for your trust.

As the market struggles and investors see their account balances fall, brokers also feel the pinch. With many advisors charging fees based on assets under management, there's always a possibility that your advisor will recommend commission-generating investments that aren't the best for you. Although it looks innocent, that amounts to outright theft.

Why you have to do your homework
Over the past two years, the credit crunch has spread from the narrow niche of subprime mortgages to threaten the nation's entire financial system. Individuals and institutional investors alike have discovered the consequences of failing to do enough due diligence before choosing their investments.

Institutional investors, however, have more clout than you do. When institutions alleged deceptive sales practices on auction-rate securities, brokers like Citigroup (NYSE: C  ) , Merrill Lynch (NYSE: MER  ) , and UBS (NYSE: UBS  ) quickly ponied up billions to make them whole. You, on the other hand, may have to make the best of a bad situation.

Don't B misled
Unfortunately, there's a financial incentive for some advisors to recommend investments that aren't necessarily in your best interest. For instance, some advisors put their clients into certain classes of mutual fund shares that charge a hefty fee if you decide to sell them within a certain number of years. These investments, known as "B shares," provide for a so-called contingent deferred sales charge, which is withheld from the proceeds of any shares you sell.

On their face, B shares have some benefits over other share classes available to retail investors. With A shares, you have to pay a sales load up front. C shares include annual 12b-1 fees that increase your expense ratio for as long as you invest. Although B-share expenses are also high, after five to 10 years, many B shares automatically convert to A shares without having to pay the load.

Unfortunately, along the way those higher expenses add up to as much or more than your broker would have earned from an up-front sales load. And more importantly, the threat of having to pay a fee to get out often deters investors from selling their fund shares -- even if they'd otherwise seek out better alternatives.

Know when to fold 'em
Sadly, many of these broker-sold load funds end up among the market's worst performers, even when you ignore the extra fees. In other words, even with lower expense ratios and no up-front or back-end costs, these funds would lag behind their no-load counterparts. Consider, for instance, the Putnam Capital Appreciation B (PCABX) fund. Unlike its comparable A shares, it doesn't charge a 5.75% sales load, but its expenses top 2% annually. And despite investing in stocks like Microsoft (Nasdaq: MSFT  ) , Medtronic (NYSE: MDT  ) , and PepsiCo (NYSE: PEP  ) -- basic stocks you'd expect to find in many large-cap funds, including index funds -- the fund has underperformed its benchmarks by multiple percentage points going back 10 years.

Several firms, such as Citi and American Express (NYSE: AXP  ) , have been fined by securities regulators for misusing B shares. Unfortunately, those fines don't necessarily mean that you'll see more money in your pocket.

What should you do if you find yourself stuck in a fund like this? Often, as painful as it is, the best thing to do is bite the bullet and pay the deferred sales charge to get out right now. Even if you wait until the fee goes away, you'll have paid just as much in higher annual expenses -- and you'll have exposed yourself to the fund's potential bad performance that much longer. Staying put in a bad fund is like throwing good money after bad -- it's not worth it.

Put your money where your mouth is
It's no fun to find out that your financial advisor may not be on your side. But with the markets down, now is a good time to look closely at your advisor's recommendations and make sure you're not paying more for less benefit.

And when it comes to B shares, just say no. With so many good alternatives out there, there's really no reason why you should ever buy a retail stock fund that forces you to lock up your money while sending a commission to your advisor. If your advisor won't sell you a better fund, find somebody else who will -- or go buy one on your own.

For more on getting good financial advice, read about:

Struggling to find a good mutual fund without big fees? Let our Champion Funds newsletter help you, with new recommendations each month along with a list of proven winners. No-holds-barred access is yours free with a 30-day trial.

Fool contributor Dan Caplinger got trapped by B shares when he was a teenager. American Express and Microsoft are Motley Fool Inside Value recommendations. The Fool owns shares of American Express. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy pays dividends.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 26, 2008, at 1:06 PM, DavidTheJust wrote:

    There is nothing wrong with getting professional advice to manage your money. If you are getting professional advice, you are going to pay for it - so don't go to a broker expecting them to recommend low cost no-load mutual funds.

    Does this make the funds recommended by brokers a bad deal? Absolutely not. One of the best fund families is American Funds which operates with meaningfully below average annual costs. You can go to the American Funds website - and compare their costs to the funds your broker is recommending. If the fees in the funds being recommended to you are meaningfully higher - ask what you are paying for. After all, it is your money.

  • Report this Comment On September 05, 2008, at 12:03 PM, bearshat wrote:

    I think the problem with load funds is that under the current law, brokers and investors cannot negotiate the load the have to pay. Whether you purchase the great First Eagle Global fund from a no service broker like E*Trade or a high service broker like Merrill Lynch, you are forced to pay the same amount. This protectionism benefits the brokers at the expense of their clients who can go nowhere else to get a better price.

    Stocks were also once sold with set commissions but institutional investors with clout forced the brokerage industry to go through the big bang which set free the price of purchasing stocks. Hence today, you can actually find brokers that charge zero commissions. But load funds are purchased by individuals (retail) who lack the clout to force a change in the current law.

    For years, market regulations have been leaning favorably to the individual investor but it still has a way to go.

  • Report this Comment On June 09, 2009, at 11:47 AM, fabeetle wrote:

    There has been a lack of user-generated content in the wealth management space. Our solution, when launched, will help people in the way's mentioned above by giving them a tool to rate, review and research financial advisors. Check us out: http://www.fabeetle.com

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