A few months ago, I was working on a Personal Wealth Action Plan with a client who told me that a year or so earlier, he directed his broker to sell everything that “could go down in value” in his portfolio. He believed his investments solely consisted of bonds and cash. Imagine my surprise to find 30% of his portfolio in large cap stock mutual funds. Not participating in the discussion a year earlier, I’m not sure why there was such a big gap between what the client thought he had and what he owned, but there are several factors at play here.
First, a little background: in the investment management world, there are two ways Advisors earn their fees: commission or management fees. In a commission relationship, a broker only makes money when a client buys or sells a security. There is a risk to have a bias toward high priced investments and more-than-necessary turnover. With ongoing management fees, there’s a risk the Advisor is getting paid but not really doing anything (this one reason why I include financial planning in my investment management fees).
The client referenced above had 30% of his portfolio in Large Cap Growth A-shares. A Shares are a type of mutual fund where investors pay a large fee upfront and a lower fee over time than other share classes of the same fund. In this case, the client had paid 5.75% of the initial investment to get into this mutual fund with an ongoing fee of ~0.8%. Because it’s so expensive to get into A Shares, selling out of them raises red flags and is strongly discouraged. So a someone who gets easily spooked by the market and wants to sell in and out is probably not a good fit for A Shares.
My intention is not to judge the situation, but to share three lessons we can all takeaway from it:
- Instead of changing investment strategies with how you feel about the market, develop an asset allocation that you are comfortable during good and bad markets. In this case, it was beneficial to the client to have 30% in large cap stock during that time period, but what if the market had pulled back with the client believing they didn’t have any exposure to a downturn? Identifying the amount of risk you’re willing to take in all markets can help avoid the classic investment mistake of buying high and selling low and take the emotion of of investing.
- Review your holdings and any fees involved annually. Personally, I don’t like A Shares because of the lack of flexibility. You can move to different funds at the same company with no fees to change, but many investors feel stuck with the fund family because of the initial fee. This can become an issue when there are changes within the fund company. In this specific example, the head of the equity division was leaving the company and analysts were concerned about successor leadership—usually a factor that would cause an investment manager to look at other funds.
- Know what you’re paying your Advisor, especially in a commission-based relationship. At my fee schedule, a 5.75% fee is like earning 5-6 years of fees in one trade. You should also know what you’re getting for those fees—How often do they review their manager selection? How do they approach rebalancing? What kind of changes do they make in portfolios to adapt to market conditions? Does their investment management fee include planning?
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