Man, 41, Has $780K Invested And Has Called Him His ‘Financial Advisor’ For 10 Years. Then He Looked At The Fine Print

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A 41-year-old engineer has spent the past decade working with a man he always called his financial advisor.

Recently, he pulled up the firm’s disclosure documents and discovered that his account is a brokerage account, his financial professional is a registered representative of a broker-dealer, and some of the mutual funds he owns carry sales loads and ongoing distribution fees.

His $780,000 portfolio has grown substantially over the years, but he’s now wondering how much of that growth has been eaten up by fees — and whether he could have been paying less.

The answer depends on the specific funds he owns, the fees he’s paying and what services he’s receiving. It also highlights a distinction many investors don’t fully understand: A financial professional can provide brokerage services, investment advisory services or both, and the legal standards and compensation arrangements can differ.

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Broker vs. Investment Adviser: The Distinction Many Investors Miss

Both brokers and investment advisers may be called “financial advisors” in everyday conversation, but they operate under different regulatory frameworks.

An investment adviser registered under the Investment Advisers Act is subject to a fiduciary duty that includes duties of care and loyalty. The SEC says an investment adviser must act in the client’s best interest and not subordinate the client’s interests to its own.

Broker-dealers are subject to a different standard under Regulation Best Interest when making recommendations to retail customers involving securities or investment strategies. That standard includes disclosure, care, conflict-of-interest and compliance obligations and requires a broker-dealer to act in the retail customer’s best interest when making covered recommendations.

Neither business model is automatically good or bad.

The important question is what type of relationship the investor actually has, what services he’s receiving and how his financial professional and firm are compensated.

The Form That Revealed Everything

The document that tipped him off was the firm’s Form CRS, or relationship summary.

SEC-registered investment advisers and broker-dealers that serve retail investors must provide Form CRS. The standardized document is designed to help investors understand whether they’re entering a brokerage relationship, an investment advisory relationship or both, as well as the firm’s services, fees, conflicts of interest and certain disciplinary history.

Investors can also use Investor.gov’s Form CRS resources to locate relationship summaries.

But Form CRS isn’t the only document worth reviewing.

He can use FINRA BrokerCheck to research his registered representative’s brokerage registrations and disclosed disciplinary history, while the SEC’s Investment Adviser Public Disclosure database can be used to research investment advisers.

The goal isn’t simply to find a different title for the same person. It’s to understand exactly what relationship he has and what he’s paying for.

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How Sales Loads And 12b-1 Fees Can Chip Away At Returns

Many mutual funds sold through brokerage channels have different share classes, and some carry sales loads.

A front-end sales load is charged when an investor purchases shares. The SEC’s investor guidance gives a hypothetical 5% sales load as an example: A $50,000 investment with a 5% load would result in $2,500 going toward the sales charge, leaving $47,500 invested.

Some mutual-fund share classes also charge ongoing 12b-1 fees. These are paid from fund assets and can cover distribution and, in some cases, shareholder services. They typically apply to mutual funds rather than ETFs.

Even a relatively small annual cost can compound over time.

For example, if $780,000 grew at 6% annually for 10 years with no additional contributions or withdrawals, it would grow to about $1.40 million before fees.

If an additional 0.25% annual cost reduced the return to 5.75%, the same portfolio would grow to about $1.36 million.

That’s a difference of roughly $33,000 after 10 years.

It’s a hypothetical illustration, not a prediction. Actual investment returns, contributions, withdrawals and other expenses would change the outcome.

Why Share Classes Matter More Than He Realized

The same mutual fund can offer multiple share classes that invest in the same underlying securities but have different expenses and sales charges.

The SEC notes that some share classes charge investors when they purchase shares, while others may charge when shares are sold. Some also have different ongoing 12b-1 fees.

That means the engineer could potentially own a higher-cost share class of a fund when another share class with different costs might be available, depending on the account type and circumstances.

The SEC’s broader investor guidance also demonstrates how seemingly small annual fee differences can compound. Its hypothetical example shows a $100,000 investment growing at 4% annually for 20 years reaching about $208,000 with a 0.25% annual fee versus about $179,000 with a 1% annual fee.

That doesn’t mean the lowest-cost fund or share class is automatically the best choice. But it does mean investors should understand what they’re paying.

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What To Do Before Moving A Single Dollar

Switching firms isn’t necessarily free or simple, so he shouldn’t start selling investments before understanding the consequences.

Selling investments in a taxable brokerage account can trigger capital gains taxes. Some mutual-fund share classes can also carry contingent deferred sales charges or other redemption fees.

He should request a complete list of his holdings, including each fund’s ticker, share class, expense ratio, sales charge and any applicable redemption fee.

He should also ask the current firm whether lower-cost share classes or alternative funds are available and what services or features would change if he moved.

If much of his $780,000 is held in an IRA, a trustee-to-trustee transfer to another IRA can generally be completed without the distribution being paid to him or current taxes being withheld. The IRS specifically distinguishes a direct trustee-to-trustee IRA transfer from a distribution paid to the investor.

That can make an IRA transfer relatively straightforward from a tax perspective, but he should still compare investments, fees and account features before making the move.

The first step may simply be asking the current firm, in writing, for a complete breakdown of what he owns and what he pays.

Finding An Adviser Who Works Under A Standard He Understands

He doesn’t need to cut ties angrily. But after 10 years, he has a reasonable reason to ask questions.

AdviserMatch connects investors with financial advisers for free, allowing him to compare financial professionals after answering questions about his assets and goals.

When he meets with potential advisers, three questions can help clarify the relationship:

Are you acting as a fiduciary for me, and in what capacity?

How are you compensated?

What will my total annual investment costs be, including advisory fees, fund expenses and other account charges?

With more than two decades potentially remaining until retirement, understanding those answers could make a meaningful difference to how much of his $780,000 ultimately remains invested and compounding for him.

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This article Man, 41, Has $780K Invested And Has Called Him His ‘Financial Advisor’ For 10 Years. Then He Looked At The Fine Print originally appeared on Benzinga.com

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