Chapter 9
Buying Funds from the Best Firms
In This Chapter
Becoming familiar with the best and worst places to buy funds
Letting discount brokers work for you
Knowing when hiring an adviser is appropriate
Hundreds of investment companies offer thousands of fund options. However, only a handful of these fund companies offer many top-notch funds, so in this chapter, I tell you which companies are the best places for your fund investing.
Some other good individual funds are run by companies not mentioned in this chapter. (I recommend specific funds in Part IV of this book.) In addition to recommending the best parent fund companies, I also recommend the best discount brokers. Although these guys are slightly more expensive, discount brokers make buying the best funds from different fund companies and holding all the funds in a single account a lot easier.
Finding the Best Buys
When studying the different mutual funds companies, you may see a lot of different funds. Some are better than others. Using the criteria in Chapter 7, this chapter presents the best buys. In this section, I discuss the best companies through which to invest in funds directly. Check out the Appendix for each company’s contact information. Note: In the fund company descriptions, I devote more space to those companies whose funds I recommend the most in this book. Some good funds are offered by companies not on this short list — please see Chapters 11 through 14 for all the specific fund picks.
The Vanguard Group
The Vanguard Group is now the largest mutual fund company in America, having surpassed Fidelity. Vanguard’s significant growth since the early 1990s has been somewhat of a vindication for a company that was underrated for many years. (At the time that I wrote the first edition of this book in 1994, I went on record as saying that Vanguard, overall, was the best mutual fund company around and wasn’t getting the recognition it deserved. My praise led some folks to ask whether I had a vested interest in praising Vanguard and the answer then is the same as today — no!)
One of the reasons for Vanguard’s underrating is the fact that its funds are almost never at the very tiptop of the performance charts for their respective categories. As I discuss in Chapter 7, this sign is actually good, because many number-one-performing funds are rarely even above average over the long haul. Although Vanguard offers a broad spectrum of funds in terms of risk, it doesn’t take excessive risks with the funds it offers; thus, its funds rarely are ranked number one over short time periods.
Because of Vanguard’s unique shareholder-owned structure (see the nearby sidebar “Vanguard’s roots: The Bogle difference”), the average operating-expense ratio of its funds — 0.22 percent per year for U.S. stock funds, 0.29 percent for international stock funds, and 0.14 percent for bond funds — is lower than that of any other fund family in the industry. In fact, the average fund family’s expense ratio is a whopping four times higher than Vanguard’s. Vanguard also offers its Admiral series of funds with lower expense ratios for higher balance customers and low-cost exchange-traded funds (see Chapter 5).
A pioneer in the field, Vanguard was the first to offer to the public index funds, which are unmanaged portfolios of the securities that comprise a given market index. Many fund companies have since added index funds to their lists of offerings. But Vanguard is still the indexing leader with the broadest selection of index funds and the lowest operating expenses in the business. (I talk more about the advantages of index funds in Chapter 10.)
Vanguard’s low expenses translate into superior performance. Especially with money market and bond funds (markets in which even the best fund managers add relatively little value), Vanguard’s funds are consistently near the head of the class.
Vanguard is best at funds appealing to safety-minded investors — those who want to invest in money market, bond, and conservative stock funds. However, Vanguard also offers aggressive stock funds with solid performance and low-expense ratios (see Chapter 13 for the list). In managing stock funds, where performance is supposed to be more closely tied to the genius of the fund manager, Vanguard’s thriftiness enhances performance.
Fidelity Investments
Fidelity Investments is the second largest mutual fund company in America. A mutual fund Goliath, Fidelity offers hundreds of funds. As evidence of Fidelity’s enormous buying power, representatives from dozens of companies visit its Boston offices every day. Most mutual fund managers have to travel to the companies they’re interested in researching; if you’re a Fidelity mutual fund manager, however, many companies come to you.
Fidelity’s roots trace back to the 1940s, when Edward C. Johnson II took over the then-fledgling Fidelity Fund from its president, who felt that he couldn’t make enough money as the head of an investment fund! Johnson’s son, Ned (Edward C. Johnson III), assumed Fidelity’s top position in 1972 and has clearly proven that you can make a truckload of money operating mutual funds: He’s personally worth billions.
If you’re venturing to do business with Fidelity on your own, you have your work cut out for you. One of the biggest problems novice investors have at Fidelity is discerning the good funds from the not-so-good ones. (My book separates the best from the rest and highlights which Fidelity funds are worthy of your investment dollars.)
I specifically advise shunning the following types of funds at Fidelity:
Bond funds: Relative to the best of the competition, Fidelity’s bond funds charge higher operating expenses that depress an investor’s returns. (Note: For larger balance customers, Fidelity offers a decent series of bond funds known as Spartan funds that have lower operating expense ratios — see Chapter 11.)
Adviser funds: Fidelity sells this family of load funds through investment salespeople; these funds carry high sales loads or high ongoing fees.
Sector funds: You should also avoid Fidelity’s sector funds (Select), which invest in just one industry — such as air transportation, insurance, or retailing. These funds have rapid changeover of managers. Being industry focused, these funds are poorly diversified (highly concentrated) and quite risky. Fidelity, unfortunately, encourages a trader mentality with these funds.
One of Fidelity’s strengths is its local presence — it operates 100+ branch offices throughout the United States and staffs its phones 24 hours a day, 365 days a year.
Dodge & Cox
Dodge & Cox is a San Francisco–based firm that has been in the fund business since the Great Depression. It’s best known for its conservatively managed funds with solid track records and modest fees.
Unfortunately for new investors, from time to time, Dodge & Cox has closed some of its funds. The company did so to keep funds from becoming too bloated with assets to manage, which could undermine the performance of those funds. Thanks to the severe stock market decline in the late 2000s, all its funds were reopened and remain so as of this writing. However, if any of its funds appeal to you, you should establish an account in case it shuts any of its funds again to new investors.
Oakmark
Harris Associates, which has managed money since 1976, is the investment management company that oversees the management of Oakmark, this value-oriented Chicago-based family of funds.
As with the Dodge & Cox funds (see the preceding section), a number of the best Oakmark funds have closed from time to time to new investors. As of this writing, all its funds are open. Be aware that when some of its funds have closed in the past, investors who establish accounts directly with Oakmark can still buy some of the closed funds.
T. Rowe Price
Founded in 1937, T. Rowe Price is one of the oldest mutual fund companies — named after its founder, T. (Thomas) Rowe Price, who’s generally credited with popularizing investing in growth-oriented companies. The fund company has also been a fund pioneer in international investing.
T. Rowe Price remained a small company for many years, focusing on its specialties of U.S. growth stocks and international funds. That stance changed in recent decades as the company offered a comprehensive menu of different fund types. It offers 401(k) retirement plans specifically for smaller companies. The fund company also offers a series of lower cost money market and bond funds called Summit funds with a minimum initial investment of $25,000.
TIAA-CREF
This nonprofit organization provides an array of investment services to education, hospitals, and other nonprofit organizations and offers a solid family of funds to the general public. Its funds have low operating expense ratios and are conservatively managed.
Headquartered in New York City, the company has major operations in Charlotte, North Carolina, and Denver, Colorado, as well as about 60 local offices. The organization got its start in 1918 when Andrew Carnegie and his Carnegie Foundation established a pension system for professors. Funding initially came from grants from the foundation and Carnegie Corporation of New York, and regular contributions from participating institutions and individuals. Today, TIAA-CREF invests more than $400 billion on behalf of investors.
The funds’ low minimums make them a good choice for investors with smaller sums to invest. They have no-minimum-investment IRAs with no annual administrative fees.
Other fund companies
With so many companies offering mutual funds, the number of them competing for your mutual fund dollars far exceeds those that are worthy of your consideration. But here are some additional noteworthy fund companies:
Artisan: This small family of well-managed stock funds is headquartered in Milwaukee, Wisconsin. Unfortunately, as the popularity of some of its funds has grown over the years, some of them have closed. As of this writing, the Artisan International Small Cap Fund, Artisan Mid Cap Fund, Artisan Mid Cap Value Fund, and Artisan Small Cap Value Fund are closed to new investors.
Harbor: Based in Toledo, Ohio, Harbor Funds contracts with outside money managers who manage money for affluent individuals and institutions. Although Harbor fund managers don’t take great risks, their funds are expected to — and are generally able to — outperform comparable market indexes.
Masters’ Select: The investment advisory firm of Litman/Gregory, which manages money for affluent individuals and institutions, developed this unique and small family of funds in 1997. Each of the funds within this family, which is based in Orinda, California, contracts out the actual management of the investment dollars to a handful of top fund managers.
USAA: Headquartered in San Antonio, Texas, USAA is a conservative family of efficiently managed mutual funds (and generally low-cost, high-quality insurance). Although you (or a family member) need to be a military officer, enlistee, or military retiree to gain access to its homeowner and auto insurance, anyone can buy its mutual funds. USAA also offers investors, with small amounts to invest (minimum of $50 monthly) and without several thousand dollars required to meet fund minimum requirements, the ability to invest via electronic monthly transfers. For more info on USAA’s funds, check out its Web site at www.usaa.com/inet/ent_utils/McStaticPages?key=investments_mutual_funds_main.
Hundreds of mutual fund companies offer thousands of funds. Many aren’t worth your consideration because they don’t meet the common-sense selection criteria outlined in Chapter 7. So if you’re wondering why I didn’t mention a particular fund family, it’s probably because the record shows that its funds are high cost, low performance, managed in a schizophrenic fashion, or all of the above. Check them out against the criteria in Chapter 7 to see for yourself. (Note: In Part IV, where I recommend specific funds in varying fund categories, I also mention some other funds offered by companies that aren’t specifically written up in this chapter.)
One of the beauties of all the fund choices out there is that you don’t have to settle for mediocre or inferior funds. If you’re wondering what to do with such funds that you already own, please read Chapter 17.
Discount Brokers: Mutual Fund Supermarkets
For many years, you could only purchase no-load mutual funds directly from mutual fund companies. If you wanted to buy some funds at, say, Vanguard, Oakmark, T. Rowe Price, and Dodge & Cox, you needed to call these four different companies and request each firm’s application. So you ended up filling out four different sets of forms and mailing them in with a separate check to each of the companies.
Soon, you received separate statements from each of the four fund companies reporting how your investments were doing. (Some fund companies make this even more of a paperwork nightmare by sending you a separate statement for each individual mutual fund that you buy through them.)
Now suppose that you wanted to sell one of your T. Rowe Price funds and invest the proceeds at Oakmark. Doing so was also a time-consuming pain in the posterior, because you had to contact T. Rowe Price to sell, wait days for it to send you a check for the sale’s proceeds, and then send the money with instructions to Oakmark. Shopping this way can be tedious. Imagine wanting to make a salad and having to go to a lettuce farm, a tomato farm, and an onion farm to get the ingredients. That’s why we have supermarkets!
In 1984, Charles Schwab came up with the idea to create a supermarket for mutual funds. Charles Schwab is the discount broker pioneer who created the first mutual fund supermarket (which other discount brokers have since copied) where you can purchase hundreds of individual funds from dozens of fund companies — one-stop mutual fund shopping.
The major benefit of such a service is that it greatly simplifies the paperwork involved in buying and selling different companies’ mutual funds. No matter how many mutual fund companies you want to invest in, you need to complete just one application for the discount broker. And instead of getting a separate statement from each company, you get one statement from the discount broker that summarizes all your mutual fund holdings. (Note: You still must maintain separate nonretirement and IRA accounts.)
Moving from one company’s fund into another’s is generally a snap. The discount broker can usually take care of all this with one phone call from you. Come tax time, you receive just one 1099 statement summarizing your fund’s taxable distributions to record on your tax return.
You weren’t born yesterday, so you know that all this convenience must have a catch. Here’s a hint: Because discount brokers serve as intermediaries for the buying and selling of funds and the time and money spent sending you statements, they expect to make some money in return. So guess what? It costs you more to use a discount broker. Discount brokers charge you a transaction fee whenever you buy or sell most of the better funds that they offer. Leading discount brokers typically charge a flat fee of around $35.
Buying direct versus discount brokers
Buying funds directly from fund companies versus buying funds through a discounter’s mutual fund supermarket isn’t inherently better. For the most part, it’s a trade-off that boils down to personal preference and individual circumstances.
Why to buy funds direct
Many reasons exist to buy funds directly from the company. Here are a few:
You’re thrifty. And you can take that as a compliment. Being vigilant about your investing costs boosts your returns. By buying direct from no-load fund companies, you avoid the discount brokerage transaction costs.
You don’t have much money to invest. If you’re investing less than $5,000 per fund, the minimum transaction fees of a discount broker will gobble up a large percentage of your investment. You don’t have to hassle with transaction fees when you buy direct from a no-load fund company.
You’re content investing through one of the bigger fund companies with a broad array of good funds. For example, if you deal directly with one mutual fund company that excels in all types of funds, you can minimize your fees and maximize your investment returns. Given the breadth and depth of the bigger companies’ fund selections, you should feel content centralizing your fund investments through one of the better companies. However, if you sleep better at night investing through multiple fund companies’ funds, I won’t try to change your mind.
Given the fact that most of the major fund companies, such as Vanguard, Fidelity, and T. Rowe Price, have discount brokerage divisions offering mutual funds from companies other than their own, you could use one of these companies as your base and have the best of both worlds. Suppose, for example, that you want to invest a large portion but not all your money in Fidelity funds. By establishing a discount brokerage account at Fidelity, all your Fidelity fund purchases would be free of transaction fees; then through that same account, you could also buy other fund companies’ funds.
Why to buy through a discount broker
Here are the main reasons to go with a discount broker:
You want to invest in funds from many fund companies. In general, different fund companies excel in different types of investments: You may want to build a portfolio that draws on the specific talents of various companies. Although you can buy directly through each individual fund company, the point eventually comes where the hassle and clutter just aren’t worth it. The one-stop shopping of a discount broker may well be worth the occasional transaction fee.
You hate paperwork. For those of you out there whose disdain of paperwork is so intense that it keeps you from doing things that you’re supposed to do, a discount broker is for you.
You want easy access to your money. Some discount brokerage accounts offer such bells and whistles as debit cards and unlimited check-writing privileges, making it simple for you to tap in to your money. (That can be a bad thing if this tempts you to spend your money!)
You want to buy into a high-minimum fund. One unique feature available through some discount broker’s fund services is the ability to purchase some funds that aren’t normally available to smaller investors.
You want to buy funds on margin. Another interesting but rarely used feature that comes with a brokerage account is that you can borrow on margin (take out a loan from the brokerage firm) against mutual funds and other securities (which are used as collateral) held in a nonretirement account. Borrowing against your funds is generally lower cost than your other loan options, and it’s potentially tax deductible. That said, buying and holding funds on margin can be costly and risky, and you may be forced to sell some funds or add cash to your account if the value of your investments declines too much.
You have a way (that involves hassle) to buy and sell your funds and use a discounter but reduce the total transaction fees: Purchase your funds initially from the mutual fund company and then transfer the shares at no charge into a discount brokerage account. Conversely, when you’re ready to sell shares, you can transfer shares from the discounter to the mutual fund company before you’re ready to sell. (See Chapter 16 for details about transfer forms.)
Debunking “No Transaction Fee” funds
After several years of distributing funds for all these different fund companies, discount brokers came up with another innovation. Discount brokers were doing a lot for mutual fund companies (for instance, handling the purchase and sale of funds, as well as the ongoing account recordkeeping and reporting), but they weren’t being paid for all their work.
In 1992, Charles Schwab & Company negotiated to be paid an ongoing fee to service and handle customer accounts by some mutual fund companies. Today, through Schwab and other discount brokers who replicated this service, you can purchase hundreds of funds without paying any transaction fees (that is, you pay the same cost as if you’d bought the funds through the mutual fund company itself). These are called No Transaction Fee (NTF) funds.
On the surface, this idea certainly sounds like a great deal for you — the mutual fund investor wanting to buy funds from various companies through a discount brokerage account. You get access to many funds and one account statement without paying transaction fees.
The no-transaction fee fund is a case of something sounding much better than it really is. Although some discount brokers say or imply that NTF funds are free, they’re hardly free. Discount brokers are able to waive the transaction costs only because the participating fund companies have agreed to foot the bill. In a typical arrangement, the participating fund company shares a portion of its operating expense ratio with the discount broker handling the account. But as you know if you read Chapter 7, annual operating expenses are drawn from the shareholders’ investment dollars. So in the end, you’re still the one paying the transaction costs.
As a group, NTF funds are inferior to the best no-load funds that you pay the discounters a transaction fee to purchase because NTF funds tend to
Have higher operating expenses than non-NTF funds
Be offered by smaller, less experienced fund companies who may be struggling to compete in the saturated mutual fund market
You’ll notice that big, well-established fund companies (including the ones discussed earlier in this chapter, such as Vanguard, Fidelity, and T. Rowe Price) don’t participate in NTF programs. They don’t have to; the demand for their funds is high even with transaction costs.
In their rush to sign up more NTF funds, some discounters have ignored the quality of the NTF funds they offer. Some financial publications encourage and effectively endorse this lack of quality control by giving higher ratings (in articles purporting to review and rate various discount brokers) to those discounters offering more “free” funds to customers. As with a restaurant meal, more isn’t always better — quality counts as well!
Whenever you make a mutual fund investment decision through a discount broker, try not to be influenced by the prospect, or lack thereof, of a transaction fee. In your efforts to avoid paying a small fee today, you can end up buying a fund with high ongoing fees and subpar performance. If you’re so concerned about paying additional fees, deal directly with mutual fund companies and bypass the discount brokers and their transaction fees.
Using the best discount brokers
Although I’ve spoken of mutual fund companies and discount brokers as separate entities, the line between them has greatly blurred in recent years. For example, Schwab started as a discount broker but later began selling its own mutual funds. Other companies started selling mutual funds but have now moved into the discount brokerage business. The most obvious example is Fidelity, which offers brokerage services through which you can trade individual securities or buy many non-Fidelity mutual funds.
Vanguard and T. Rowe Price have excellent discount brokerage divisions that offer an extensive array of funds from other leading fund companies and charge competitive transaction fees. Vanguard charges $35 per trade and $3 for regularly scheduled dollar-cost averaging trades (minimum of $100); T. Rowe Price charges $35 per trade.
The discount brokerage services of Fidelity, Vanguard, or T. Rowe Price make a lot of sense if you plan on doing the bulk of your fund investing through their respective funds. Remember, you only have to pay brokerage transaction fees on funds offered by other fund companies. You won’t pay for buying a Fidelity fund from Fidelity or a Vanguard fund from Vanguard or a T. Rowe Price fund from T. Rowe Price.
If you’re already wondering how to get in touch with the companies that I recommend in this chapter, check out the Appendix, which includes the phone numbers, Web sites, and mailing addresses for all these companies. But before you put the cart before the horse, I strongly recommend that you at least read through Part IV of this book. That’s where I recommend specific funds and discuss how to assemble a top-notch portfolio of funds.
Places to Pass By
Don’t base your investment decisions on your gut: Some mutual fund companies have plush offices and they charge relatively high fees for their funds (to pay for all their overhead costs) or sell poorly performing funds — or both. What types of places are likely to make you feel comfortable but lead you astray? Many people do their fund investing through a list of wrong places:
The First Faithful Community Bank: Many people feel comfortable turning their money over to the friendly neighborhood banker. You’ve done it for years with your checking and savings accounts. The bank has an impressive-looking branch close to your home, complete with parking, security cameras, and a vault. And then there’s that FDIC insurance that guarantees your deposits. So now that your bank offers mutual funds, you may feel comfortable taking advice from the “investment specialist” or “consultant” in the branch (and may erroneously believe that the funds it sells carry FDIC coverage).
Well, the branch representative at your local bank is probably a broker who’s earning commissions from the mutual funds he’s selling you. Bank funds generally charge sales commissions and higher operating expenses and generally have less-than-stellar performance relative to the best no-load funds. And because banks are relatively new to the mutual fund game, the broker at your bank may have spent last year helping customers establish new checking accounts and may have little knowledge and experience with investments and mutual funds. Remember, if he’s working on commission, he’s a salesperson, not an adviser. And the funds he’s selling are load funds. You can do better.
Plunder and Pillage Brokerage Firm: Brokers work on commission, so they can and will sell load funds. They may even try to hoodwink you into believing that they can do financial planning for you. Don’t believe it. As I discuss in Chapter 7, purchasing a load fund has no real benefit; you have better alternatives.
Fred, the Friendly Financial Planner: You may have met Fred through a free seminar, adult education class, or a cold call that he made to you. Fred may not really be a financial planner at all; instead, he could be a salesperson/broker who sells load funds. (If you want to hire an objective planner or adviser for investing in funds, see the next section.)
Igor, Your Insurance Broker: Igor isn’t just selling insurance anymore. He now may sell mutual funds, as well, and may even call himself a financial consultant. (See the preceding remarks for brokers.)
The Lutheran-Turkish-Irish-Americans-Graduated-from-Cornell-and-Now-Working-in-the-Music-Business Fund: Hoping to capitalize on the booming fund business, special interest groups everywhere have been jumping in to the fray with funds of their own. Don’t be surprised if your church, your alma mater, or your ethnic group makes a passionate pitch to pool your money with that of like-minded individuals in the hands of a manager who truly understands your background.
Although something can possibly be said for group solidarity, I suggest leaving your nest egg alone. Such special-interest funds carry loads and high operating fees and, because they have relatively little money to manage, are usually managed by money managers with little experience.
Hiring an Adviser: The Good, Bad, and Ugly
Dealing directly with various fund companies or simply selecting funds from among the many offered through a discount brokerage service may seem overwhelming to you. But don’t hire an adviser until you’ve explored the real reasons why you want to hire help. If you’re like many people, you may hire an adviser for the wrong reason. Or you’ll hire the wrong type of adviser, an incompetent one, or one with major conflicts of interest. Check out the following sections for the highlights of why you should and why you shouldn’t hire an adviser for overall advice.
The wrong reason to hire an adviser
Don’t hire an adviser because of what I call the crystal ball phenomenon. Although you know you’re not a dummy, you may feel that you can’t possibly make informed and intelligent investing decisions because you don’t closely follow or even understand the financial markets and what makes them move. Don’t believe any advisor who claims he saw particular events (for example, the early 2000s bear market, the late 2000s financial crisis) coming in advance and perfectly positioned his clients’ investment portfolio.
No one who you hire has a crystal ball. No one can consistently predict future movements in the financial markets to know which types of investments will do well and which ones won’t. Investing intelligently in mutual funds isn’t that complicated. You bought this book, so read it, and you find out all you need to know to invest wisely in funds.
The right reasons to hire an adviser
Consider hiring an adviser if
You’re too busy to do your investing yourself.
You always put off investing because you don’t enjoy doing it.
You’re uncomfortable making investing decisions on your own.
You want a second opinion.
You need help establishing and prioritizing financial goals.
Beware of conflicts of interest
The field of investment and financial planning is booby-trapped with land mines awaiting the naive investor. A particularly dangerous one is the enormous conflict of interest that’s created when “advisers” sell products that bring them commissions.
If a financial planner or financial consultant sells products and works on commission, he’s a salesperson, not a planner — just as a person who makes money selling real estate is a real estate broker, not a housing consultant! There’s nothing wrong with salespeople — you just don’t want one spouting suggestions when you’re looking for objective investment and financial-planning advice.
Here are some of the problems created by commission-based advice:
Investments that carry commissions can pit your interests against those of the broker selling them. The bigger the commission on a particular investment product, the greater the incentive the broker/planner/adviser has to sell it to you.
Investments that carry commissions mean that you have fewer dollars working in the investments you buy. Commissions are siphoned out of your investment dollars. When it comes to returns, non-commission investments have a head start over commission ones.
Investments that carry the highest commissions also tend to be among the costliest and riskiest financial products available. They’re inferior products; that’s why they need high commissions to motivate salespeople to sell them.
Planners who work on commission have an incentive to churn your investments. Commissions are paid out whenever you buy or sell an investment (every time you make a trade). So some commission-greedy brokers/planners encourage you to trade frequently, attributing the need to changes in the economy or the companies in which you’ve invested. Not only does heavy trading fatten the broker/adviser’s wallet at your expense, but also it’s a proven loser as an investment strategy. (See Chapter 10 for more about investment strategies and your portfolio.)
Planners who work on commission may not keep your overall financial needs in mind. You may want to fund your employer-sponsored retirement plan or pay off your mortgage or credit card debt before you start investing. The commission-based and money-managing planner has no incentive to recommend such strategies for you; that would give you less money to invest through them.
Planners who work on commission may create dependency. They may try to make it all so complicated that you believe you can’t possibly manage your finances or make major financial decisions without them.
Your best options for help
You must do your homework before hiring any financial adviser. First, find out as much as you can about the topic you need help with. That way, if you do hire someone to help you make investment and other financial decisions, you’re in a better position to evaluate his or her capabilities and expertise.
Realizing that you need to hire someone to help you make and implement financial decisions can be a valuable insight. Even if you have a modest income or modest assets, spending a few hours of your time and a few hundred dollars to hire a professional can be a good investment. The services that advisers and planners offer, their fees, and their competence, however, vary tremendously.
Financial advisers make money in one of three ways:
From commissions based on sales of financial products
From fees based on a percentage of your assets that they’re investing
From hourly consultation charges
If you read the preceding section, you already know why the first option is the least preferred choice. (If you really want to or are forced to work with an investment broker who works on commission, be sure to read the last section in this chapter — “If you seek a salesperson.”)
A generally better choice than a commission-based broker is a planner who works on a fee basis. In other words, the planner is paid by fees from clients such as you, instead of from the investments and other financial products that he or she recommends that you buy. This compensation system removes the incentive to sell you products with high commissions and churn your investments through a lot of transactions to generate more commissions. However, this system still has potentially significant conflicts of interest.
Many of the leading discount brokerage and mutual fund companies now offer advisory services (either in-house or through referrals), which typically perform mutual fund management for a percentage of assets under their care. With their in-house asset management, you probably won’t be able to get the hand-holding, handshakes, and eye-to-eye contact that you would by hiring a local financial-planning firm. However, if you’re looking at hiring a financial adviser, I encourage you to consider and interview the advisory divisions of the firms discussed in this chapter. Just be sure to put them through the questions that I recommend in Chapter 24.
The most cost-effective method is to hire an adviser who charges an hourly fee and doesn’t sell investment and other financial products. Because he doesn’t sell any financial products, his objectivity should be greater. He doesn’t perform money management, so he can help you get your financial house in order and make comprehensive financial decisions, including selecting good mutual funds.
Your primary concern in selecting a planner, hourly based or otherwise, is hiring one who’s competent. You can address this by checking references and discovering the difference between good and bad financial advice. You have further risk if you and the adviser don’t clearly define the work to be done and the approximate total cost before you begin. Don’t forget to set your parameters upfront.
A drawback of an entirely different kind occurs when you don’t follow through on your adviser’s recommendations. You paid for this work but didn’t act on it: The potential benefit is lost. If part of the reason that you’re hiring an adviser in the first place is that you’re too busy or not interested enough to make changes to your financial situation, then you should look for this support in the services you buy from the planner.
If you just need someone as a sounding board for ideas or to recommend some specific no-load mutual funds, hire an hourly based planner for one or two sessions of advice. You save money by doing the legwork and implementation on your own. Just make sure that the planner is willing to give you specific enough advice that you can implement it on your own. Some planners charge for developing a financial plan and then will withhold specific investing advice and recommendations to create the need for you to hire them to do more, perhaps even to manage your money.
If you have a lot of money that you want managed among a variety of mutual fund investments, you can hire a financial adviser who charges a percentage of your assets under management. Some also offer financial-planning services. Some just manage money in mutual funds and other investments.
In the chapters ahead, I give you enough information for you to make wise mutual fund investing decisions. You owe it to yourself to read the rest of the book before deciding whether to hire financial help. Also, be sure to pay extra close attention to Chapter 24, which covers the ten issues to consider and questions to ask when hiring an adviser to help with mutual fund investing.
If you seek a salesperson
Despite the additional (and hence, avoidable) sales charges that apply when you purchase a load fund instead of a no-load fund, you may be forced to, or actually want to, buy a load fund through a salesperson working on commission. Perhaps you work for an employer that set up a retirement plan with only load funds as the investment option. Or your Uncle Ernie, who’s a stockbroker, will put you in the family doghouse if you transfer your money out of his firm and into no-load funds. Maybe you really trust your broker because of a long-standing and productive investment relationship (but ask yourself this: Is your success because of the broker or the financial markets?).
Protect yourself
If you’re comfortable and willing to pay commissions from 4 percent up to as much as 8.5 percent to invest in mutual funds, you have a number of ways to protect your money and well-being when working with brokers:
Be aware that you’re working with a broker. Unlike the real estate profession in which an employee’s title — real estate broker or agent — clearly conveys how she makes her money, many investment salespeople today have labels that obscure what they do and how they make money. Common misnomers include financial planner, financial consultant, or financial adviser as names for salespeople who used to be called stock, securities, or insurance brokers.
Make sure that you’ve already decided what money you want to invest and how it fits into your overall financial plans. This point is one of the most important things for you to do first if you’re going to invest through a commission-based investment salesperson. Guard against being pushed into dollar amounts and/or investments that aren’t part of your financial plan.
Make sure you get the best funds
If you’ve optimized the structuring of your finances and you have a chunk of money that you’re willing to pay as a sales charge to invest in load funds, make sure that you’re getting the best funds for your investment dollars. The criteria to use in selecting those load funds are no different from those used to select no-load funds:
Invest in funds managed by mutual fund companies and portfolio managers that have track records of expertise that take a level of risk that fits your needs, and that charge reasonable annual operating expenses.
Pay attention to the annual operating expenses that both load and no-load funds charge. These fees are deducted from your funds’ returns in much the same way that IRS taxes are deducted from your paycheck, with one critical difference: Your pay stub shows how much you pay in taxes, whereas your mutual fund account statement doesn’t show the fund’s operating expense charges. You need the prospectus for that, and even then it won’t show you what you paid in dollars for that.
Never invest in a mutual fund without knowing all the charges — sales charges, annual operating expenses, and any annual maintenance or account fees. You can find all these in a fund’s prospectus (see Chapter 8 for the scoop on how to decipher a prospectus).