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No factor will have a more profound impact on your investment performance than fees. Multiple studies have shown the higher your fees (commissions, sales loads, management fees, etc.), the lower your actual performance. Not surprisingly, higher fees don’t correlate with higher returns. What follows is a brief discussion about five common high fee investments sold today. (For full disclosure, P&A does not sell these or any other financial products.)

1) Variable annuities – The allure of tax-deferred growth and a guaranteed minimum payment for the rest of your life (or your spouse’s life) is a strong selling point for variable annuities. Throw in a death benefit in case you expire before your annuity begins paying out and how can you go wrong? For starters, variable annuities sold by a broker often pay them a 6% commission in the first year. In addition, there are rather high annual expenses including the management fees on the mutual funds within the annuity. Perhaps most unkind though is the surrender charge, which punishes those who take money out before a certain time period (typically 6-8 years). A common arrangement would be a 7% penalty in the first year, declining 1% each year thereafter. Don’t buy annuities in your retirement accounts though, as it’s already tax-deferred. If you want to own a variable annuity, we’d suggest the no-load and low fee varieties sold directly to investors by the issuing company.

2) Non-public REITsWe’ve written about these “investments” before. In a nutshell, extremely high fees and very low liquidity make these harmful to your wealth. The recent real estate bubble exposed many of these for what they are…a revenue generation tool for the selling firm and broker. Fees include 7% upfront commissions, property acquisition and disposal fees, dealer manager fees, and annual management fees. Taken together, it’s not uncommon to see 10% or more of your initial investment go bye-bye. Since these aren’t publicly traded, there isn’t a liquid market for them. The secondary market that does exist will pay you less than 50 cents on the dollar if you want out. Do your financial self a favor and pass on these.

3) Mutual funds with a sales load – You send your broker $100,000 to invest. They put $94,250 of the money to work and pocket the remaining $5,750. Does that sound like a good deal? If you think it does, then clearly you sell loaded mutual funds for a living. Sales loads are the commission a broker/financial advisor gets paid by the mutual fund company for pushing their product. There are front loads (applied when the fund is bought) and back-end loads (when the fund is sold). The rub is that you can buy the same exact mutual funds without paying the sales load, either directly through the fund company or through a fee-only investment advisor like P&A. Why take an immediate 5.75% loss on your investment by paying a load?

4) Private equity & hedge funds – Yes, there are some good private equity investments and hedge funds out there. The odds your broker has access to them is slim to none. Like much of what Wall Street sells, these investments are designed to generate high fees for the selling firm and broker. If the client makes money too, well, that’s a bonus. For both of these types of investments, 2% of assets managed plus 20% of any profits generated (sometimes over a certain hurdle rate) is fairly standard. This performance fee also goes by the name of carried interest.

5) Whole life insurance – Does someone depend on you for financial support? If the answer is yes, then you should have life insurance. The next question becomes, should you buy a term policy (20 or 30 years for example), or whole life (also known as permanent, variable, or universal insurance)? We are big fans of term life insurance. The reason being that it does what insurance is intended to do…protect your dependents in case you meet an early demise. The problem with whole life is that it attempts to incorporate a savings and investment component to the insurance policy. There are better ways to buy life insurance (term) and more efficient ways to manage an investment account, so keep the two separate. For those who’d rather know that their insurance policy will never run out (as long as premiums are paid), then whole life may be appropriate for you.

The bottom line is that you should ALWAYS know how much you’re paying with any investment. Don’t let the financial services industry give you the vampire treatment. Lean on us for unbiased advice. Our offer to help won’t result in you being sold a product. For more on “Why Fees Matter,” click the link.


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