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When we purchased our first home, I was stunned to see all the estimated costs on our closing statement: loan origination fees, appraisal fees, credit report fees, flood certification fees, recording fees, and more.  While I was overwhelmed by the number of miscellaneous costs, they were clearly spelled out, and I knew what we were paying.

For investors, it’s not always that easy.

New York Times columnist, Ron Lieber, recently wrote about the difficulty getting to the bottom of what you’re paying as an investor.  In his recent Your Money column, The 21 Questions You’re Going to Need to Ask About Investment Fees, he provides an overview of questions you should ask to learn what might be motivating the person who’s recommending that annuity or other investment product.

For example, brokers are usually paid a signing bonus for moving to a new firm, and if they don’t generate enough commission revenue for their new employer within a specific time, they have to pay the bonus back.  Someone with a deadline hanging over his head is probably more focused on earning a commission than putting your financial interests first.

While it’s important to understand a financial advisor’s motivation, some might disagree with the focus on compensation.  ‘Why should I care how someone is paid?  Aren’t they entitled to make a living? I didn’t pay anything to my broker when I bought this annuity – the insurance company paid him,’ are a few of the comments I’ve heard over the years.

The problem isn’t what the advisor is being paid, the problem is most investors don’t know what they’re paying to invest.  And companies don’t make it easy for you to find out.

This fact was reinforced for me over the last few weeks as I reviewed several products clients had purchased before they began working with TAAG.  Most were bought during the 2007-2009 Great Recession, when the pain of stock market losses pushed people to equity-indexed annuities, hedge funds and other products promising to protect them from the next big downturn.

Unfortunately, these products had significant fees and carrying costs that would offset most investment returns, but it was difficult to determine this up-front.  After a few years passed, people noticed how little their investments had grown, while the stock market had done very well.   It’s tough realizing you’ve missed out on some great years in the market, and even more disappointing to learn you’re locked into a product that has significant penalties for cashing out.

The Department of Labor’s fiduciary regulation that was to go into effect April 10, 2017 was supposed to help eliminate these situations, at least for retirement plans and IRAs. But as Chip explained in his blog last week, President Trump directed the Department of Labor to review the fiduciary rule and consider whether it should be modified or rescinded.

If it was easy to get a clear understanding of what you are being charged when you invest, I might agree that a regulation requiring investment advisors to act in their client’s best interest is unnecessary.  But I’ve become a skeptic of this ‘buyer beware’ argument over the years after reviewing hundreds of products.  Let me give you an example.

A few weeks ago, a new client asked me if they should keep or cash in an annuity, so I headed to the company’s website to do some research.  There were 11 different varieties of annuities listed, and 4 of them had the same name as the product they’d purchased.  The reports ranged from 153 to 186 pages, and after digging deeper into the descriptions, I determined that one of the 186-page prospectuses applied to their annuity investment options.  But this was just the supplemental prospectus.

There was an additional prospectus of 162 pages outlining the costs and terms of the actual annuity itself, and a third document outlining the costs of the specific variable investment account they held inside the annuity.

After digging through it all, I found the following costs:

  • An annual mortality & expense charge of .40% of the annuity value
  • An annual administrative charge of .15% of the annuity value
  • An annual fee of 1.50%, charged against the greater of the account value or protected withdrawal value (whichever is higher)
  • An annual expense fee of 1.17% for the mutual fund they hold inside the annuity
  • A transfer fee of $10 each time they want to make an investment change
  • An annual maintenance fee of $30

Altogether, they were paying 3.22% of their annuity balance each year, plus $30 in fixed fees if they never changed their investment.  They decided they were paying too much.

Unfortunately, the annuity had a contingent deferred sales charge, as most all annuities do, that would cost them 7% of the annuity value in the first two years, 6% in the next 2 years, 5% in the fifth year, 4.5% in year 6 and 4% in year 7.

If they keep the annuity, they’ll pay $3,220 or more per year on a $100,000 investment.  If they cash it in now to avoid the future charges, they’ll lose $6,000 immediately.  The cost to leave goes up with the investment balance.

And that, my friend, is how the signing bonuses, trips, and diamond rings described in Ron Leiber’s article are paid for.

Everyone is entitled to make a living, and investors should be able to make their own choices about what and with whom they want to invest.  But people need clear facts to make a decision.  The least we can do is give it to them.