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
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
Several firms, such as Citi and American Express
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.
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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.