by Craig D. Price, Certified Financial Planner® and Will Thompson, Certified Financial Planners®, Certified Financial Advisor®, Stuart, Florida

A retired couple recently asked my firm to analyze their professionally-managed mutual fund portfolio. They were dissatisfied with their investment performance and uncertain about the total fees they were paying. Following our report, they were shocked by what they learned:

  • 85% of their portfolio had been invested in the “house-brand” of mutual funds
    • “House-brand,” or proprietary mutual funds, are investment products in which the financial institution that sells the fund also acts as its investment manager. What this means, is that the financial institution is paid twice: once from your advisory fee or commission, and again from the proprietary funds’ ongoing management fees
    • Since proprietary investment products are designed and packaged by financial institutions to maximize profitability, their affiliated brokers are incentivized to market such products to their clients
    • The proprietary funds did not contain the name of the mutual fund company, so it was not readily apparent they were proprietary
  • Their proprietary funds were trapped at the mutual fund company because they were non-transferrable
    • Their broker had not disclosed to them that their proprietary mutual funds could never be transferred to another investment firm
  • The couple only had two undesirable options:Stuart Florida Investment Advisors
    • Liquidate their entire proprietary fund portfolio and incur $60,000 of capital gains tax

OR

  • Keep their proprietary mutual funds with the current firm, despite their general dissatisfaction

The couple was angry and frustrated when they learned that their money was being held hostage by a restrictive transfer policy that favored the investment company at their expense.

Buyer Beware

When you invest in mutual funds, be wary of proprietary products. Although there are many satisfactory proprietary funds, they often have additional restrictions, including the inability to transfer the mutual fund shares to another firm as well as an assortment of assessed fees that will affect your ultimate return. If you do buy a proprietary financial product for your portfolio, make sure to read the fine print.

If your current advisor is strictly a commission-based broker, his advice is only held to the standard of making “suitable” recommendations. That is, brokers are required to find you investment products that are suitable for factors like your investment objectives, financial means and age. But, with the myriad funds and securities investment options available to retail investors, what would be considered suitable is obviously very broad. So, as long as your broker is providing you investment options that are “suitable” for your current investment criteria, there are no barriers to your broker pushing “house” products like proprietary mutual
funds, which may help them generate better commissions and associated sales fees.

In contrast, if your financial advisor is a registered investment advisor, then he or she is an investment fiduciary under securities law. This means that your investment advisor is required to put you in only the very best products they can, and to act in your own best interest, not their own. Further, the higher fiduciary standard requires your advisor to fully disclose additional fees and transferability restrictions prior to your purchase. If you currently work with a broker, remember he is not required to act as a fiduciary when advising you. Before purchasing a proprietary mutual fund, protect yourself and ask about the fund’s transferability restrictions as well as the commissions and fees that your broker will reap if you invest in a proprietary product. That way, your money will never be held hostage and your potential return will be maximized.

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