Are financial companies creating confusion on purpose?

One of the benefits of running a low-fee fiduciary investment and financial planning firm is that I’m comfortable explaining how other finance companies create confusion and charge massively overinflated fees.  Most of our clients pay 20-50% less than of the cost of the national average total fee of 1.22% (source- RIA in a BOX).  That total fee includes advising + fund costs (expense ratio).  At Arrow, we charge 0.4-0.9% with average fund fees around 0.01-0.1%.  For folks with larger accounts, this translates into thousands of extra dollars per year.  The reality is that fees are one of the best predictors of fund performance, which means that paying high fund and advising costs loses you money with no real benefit.

The benefits of using a professional service include proper portfolio construction, allocation management, fund research, re-balancing strategy, tax strategy inside and outside IRA’s, risk assessment, financial, retirement, tax, and estate planning.  All these things can be done for fees less than 1%, so why pay extra to get nothing?  One of the primary myths about the financial industry is that you’re getting something for high fees, when, most identical services can be offered at the cost that Arrow or other low-fee firms can offer them.  But why would many of these larger, entrenched financial companies change this structure when it generates so much income at your expense?  Instead of lowering their fees or choosing lower cost funds, they instead try to obfuscate and create confusion.  So, today I’d like to talk about the myths they spread.

The Guilty Parties

What type of companies take advantage of their clients the most?  I’d like to break this into three categories:

Brokers that charge commissions (e.g., Edward Jones).  Many investment companies are actually broker-dealers that don’t have a true fiduciary duty to their clients.  This means they can use funds that have load costs (a % that is immediately charged to you when you purchase a fund) and take commissions (a % charged when you make a trade).  Why would a broker want to use a fund that immediately makes your value go down?  Because they receive a “kickback” for selling clients into the fund, something that true fiduciaries cannot do.  A fiduciary is always on the same side as you, which means when you make money, they make money with a flat % fee.

Any advisory company that charges more than 1% (e.g., Fisher Investments).  There are many fiduciary investment advisory companies that also charge massive fees with no added benefit, simply because they are large and have huge marketing networks.  Many of these companies charge fees of up to 1.5% per year to build portfolios that are identical to smaller companies.  There is no added benefit to the client, other than higher costs.  To make matters worse, many of these companies don’t offer personalized financial planning on social security, Medicare, insurance, estate planning, and other important features.  Instead, they use pre-made templates to simply forecast your future portfolio growth, and call that a comprehensive plan (it isn’t).

Insurance companies via annuities (e.g., John Hancock, MetLife etc.).  Annuities have been a cornerstone of investment planning for retirees for a very long time, because at first glance, they seem like an ideal investment product.  You put in a lump or periodic sum, the principal is guaranteed with an insurance benefit, and the insurance company claims you will receive $3,000 a month for the rest of your life, which seems like a good way to secure your lifestyle in your later years.  However, lurking in the shadows and hidden from sight is the ugly truth about annuities.  Their complex web of surrender charges, hidden fees, earnings caps, and “fine print” reveal an extremely predatory product that enriches insurance companies at the expense of hard-working Americans.

• Surrender charges: All annuities have penalties for participants that switch out of them within a specified period.  The insurance company charges these penalties so they can recoup the initial cost of the annuity plus any sales commission to the salesperson that sold it. The result is that annuities are decidedly less flexible than most investment products.

• Mortality, expense and administrative fees: The insurance company generally deducts a variety of fees for annuity maintenance, bookkeeping and administration.  These fees are based on the total value of the annuity and run between 1 and 1.5% annually.  

• Mutual fund fees: Participants also pay management fees or expenses imposed by the funds they are invested in (called an expense ratio), just like they would with any other type of investment.  In annuity lingo these are called “sub-accounts”, and their overall cost can vary widely.  

• Special features: Special features on annuity products impose additional fees. For example, an investor might pay for a small additional death benefits or a cost-of-living provision, but these costs can add an additional 0.3 to 0.8% onto the base fee amount.

• Earnings caps: Many annuities set floors on market performance so the participants account value cannot go down below a specified value, but they usually also have an earnings cap that limits upside potential when the stock market is performing well. For example, a fund with a 10% cap will only earn that much even if the underlying investment earns 18%.  This can lead to significant “losses” over the long term.

Myth #1:  Our funds are special.

The only thing “special” about branded funds is that they have higher fees and the company selling it gets a higher percentage of your money.  Think of this way:  why would you want to purchase a “name-brand” S&P 500 fund for 0.5% when you can purchase an identical fund for far less?  They hold the same assets and have the same performance *before* the fees.  To make matters worse, the “actively managed” funds touted by some companies with massively inflated fees have been shown to under perform.  This is why Arrow focuses on low-fee index funds with proper management.  It provides the best performance and saves our clients’ money.  It’s common for many of these funds to have 5% load costs, meaning you immediately lose 5% of your money, and then they still under perform lower cost funds.

The benefit of using a fiduciary is that you know they receive nothing for putting you in certain funds.

Myth #2:  We have more resources

How many financial advisors have you had in your life?  Have you noticed how each company assigns you one person to be your advisor?  Regardless of the size of the company, each client is paired with one advisor.  The only difference between a small company and large company is the number of advisors they have employed, and the size of the marketing department.  In other words, your trust in your advisor is far more important than the size of their marketing department.

Another truth about the financial industry is that most companies (regardless of size) use the same investment banks (custodians) to hold their accounts. For example, Arrow uses BNY Melon Bank/Pershing, which is the largest custodian in the world.  Imagine my surprise when I hear people say their money is “safer” at big investment firms, even though the custodian that actually holds the money is smaller and less financially secure than BNY, which has over 30 trillion dollars in assets!

The reality is that the same custodian and broker tools, research, portfolio management, and financial planning software is available to all registered investment advisors, regardless of their size.  Any company that says “we have more resources” or “we are larger and more stable” is trying to scare you into using them. 

Myth #3 Your money is safer with us

Myth 2 directly leads us to number 3.  As you can see, the size of the investment advisory company doesn’t correspond to the stability and size of the investment bank (custodian) that they use to hold your accounts.  Further, there is a limit of $500,000 SIPC insurance (including $250,000 cash) on all investment accounts in the U.S.  SIPC insurance protects against losses of cash, stock, and bonds that might occur because of insolvency of a custodian or broker-dealer, including potential fraud.  It does not protect from loss of value from market fluctuations.  There is nothing that an advisory company can do to increase this amount.  So, the idea that “your money is safer with us” is another scare tactic used to charge you more for using a larger, fee predatory company.

Myth #4:  Annuities are the only thing that can protect you from market losses

A fixed income portfolio developed by a fiduciary investment advisor can generate a steady interest-based payout at a much lower fee basis than any annuity product.  These portfolios invest in bonds, short term treasuries, real estate, and dividend paying stock, and can easily target between 3 and 5% annual return on your investment.  More importantly, the fees are likely to be nearly half of an annuity. 

Many investors are concerned with the risk involved in being a portfolio like this, but the reality is that the same type of safeguards used by insurance companies in annuities can be baked into certain types of funds in a fixed income portfolio as well.  For example, consider the defined outcome ETF’s offered by Innovator Capital Management, which simultaneously buffer downside losses and cap gains.  Sounds a lot like an annuity, right?  The reality is that many types of downside protection can be used in a fixed income portfolio for a much cheaper overall cost than in an annuity.