Insuring That Broker Does What’s Best for You
It doesn’t rank up there with the meaning of life, the Big Bang theory and other cosmic imponderables, but the mutual fund business has a conundrum of its own: If people can buy good funds without facing a sales charge, why do so many--a majority, in fact--go to a broker and pay a commission?
Die-hard no-load investors might never understand such seemingly odd behavior, but it’s not such a big riddle to people lacking the time, knowledge or inclination to make investment decisions on their own.
These individuals look to brokers to recommend and purchase an appropriate mix of mutual funds, monitor the portfolio and provide investment updates.
But not all brokers exercise good judgment, provide satisfactory service or, in short, do what’s best for the client. For this reason, it pays even for unsophisticated investors to know something about brokers and the way they sell mutual funds.
The following tips can help:
Don’t rush into anything. Many brokers or registered representatives routinely find new clients by placing cold calls over the phone. Often, this involves a sales pitch that spotlights a specific product--such as a bond fund that yields more than bank accounts pay.
Resist the temptation to buy anything spur of the moment, no matter how good it sounds.
“The broker should urge you to come in and meet with him; the product pitch is usually just an opening,” says Dan Jamieson, editor of Registered Representative, an Irvine-based trade magazine for brokers. “Never buy anything over the phone from someone you’ve never met.”
Unlike a hot stock, mutual funds rarely fluctuate much on a daily basis so you can afford to wait a few days to ponder your move and meet the broker.
Learn the basics. Brokers are good sources of investment expertise, but clients still need to think for themselves. Before you buy, at least know what factors make stock and bond prices rise and fall. You should also have some knowledge about mutual funds, their risks and fees.
The arbitration panels that decide broker-client disputes are tending to assign more responsibility to investors for taking charge of their own financial affairs, says Michael Paule, senior vice president at Investors Arbitration Services Inc. in Woodland Hills.
“People have ultimate responsibility for their own money,” he says.
Several good books have been written on mutual funds, along with numerous newspaper and magazine articles. Fund companies offer free literature explaining how their products work.
In addition, the Investment Company Institute (1600 M St. NW, Suite 600, Washington, D.C. 20036) provides two free pamphlets for beginners: “What is a Mutual Fund? 8 Fundamentals” and “An Investor’s Guide to Reading the Mutual Fund Prospectus.”
Study the sales charge. Brokers are entitled to earn a living, which explains why they sell funds that charge commissions. The more relevant question is whether they’re pushing a particular fund that imposes too high of a load or an inappropriate type of fee.
Funds can charge loads of up to 8.5% (9.3% of the amount invested) although relatively few do anymore. As a rule, there’s no reason to pay more than 6% or so on stock funds and perhaps 4.5% on bond funds, and you can find many good products that charge less.
The more difficult question is deciding whether to pay a one-time, upfront load or an ongoing sales charge, known as a 12b-1 fee. High 12b-1 fees of 1% a year or more can, over time, exceed a single 8.5% load.
“Generally, the longer you plan to stay in a fund, the better off you are paying the load upfront,” Jamieson says.
However, one advantage to paying reasonable 12b-1 fees of 0.5% to 0.75% or less, he says, is that they give the broker an incentive to monitor an account and provide ongoing advice and service.
According to Paule, a common arbitration complaint is that a person buys a front-end load fund and never hears from the broker again.
Lean toward independent funds. Reps at large national brokerages may sell their firm’s own mutual funds as well as load products managed by unaffiliated companies. Although some brokerage-run funds have superior track records, it’s often best to buy an independent fund for three reasons.
First, you need objective recommendations from your broker, but you might not get them from a rep who plugs his firm’s own products. Second, brokerages often pressure their salespeople to market in-house funds, and it’s hard for investors to know when this pressure is being applied.
Third, if your broker transfers to a rival firm, he could have problems monitoring the in-house funds he sold you.
In short, if you do buy any brokerage-run portfolios, limit your purchases to those that are clearly at the top of their class.
Beware brokers in sheep’s clothing. With yields low right now, there’s a possibility you might buy a mutual fund from a broker and not even realize it. Where might this happen? At a bank.
A rising percentage of all fund sales are generated in bank lobbies by registered reps working a few yards from tellers. Usually, you can buy the same load funds at a bank that you can at any brokerage.
The main point to remember is that no mutual funds anywhere, including those sold at a bank, carry federal deposit insurance. And keep in mind that you will also pay a commission in some form or another--a factor you didn’t have to consider with certificates of deposit.
