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Many financial advisors recommend investments with outrageous fees -- and demand substantial fees themselves. Photo: Flickr user kev-shine.
Recently, a close friend of mine rolled over a 401(k) account from a former employer into an IRA through a well-known brokerage. The events that followed are a scary reminder of how Wall Street salesmanship can stealthily rob you of huge amounts of your retirement savings.
There's a time and a place for a financial advisor
The idea of a financial advisor makes perfect sense. These folks are professionals. They eat and breathe financial planning. They are paid to make your money do more.
And for many investors, that holds true. Wealthy individuals who need assistance with complex estate planning, tax issues, and sophisticated hedging receive tremendous benefit from a top-notch advisor.
Most of us, however, are not wealthy investors. Most of us are ordinary Americans making monthly contributions into a tax-advantaged retirement account.
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Enter the salesman
Soon after opening the IRA account, my friend received a courtesy call from an advisor at the brokerage firm, which shall remain unnamed. The advisor was professional, polite, and easygoing. There were no high-pressure sales tactics. He seemed genuinely interested in helping my friend manage his new account.
The advisor offered to fully manage the account -- choosing a balanced portfolio of diversified mutual funds, monitoring them, and rebalancing as necessary -- for the industry-standard fee of 1% of the total assets in the account annually.
Uncertain, my friend asked for a few days to think it over. In the meantime, the advisor offered to work up and share a hypothetical portfolio based on my friend's age, income, and existing retirement savings. It was a chance to kick the tires, if you will, for free.
What a nice guy, right?
The fine print
A few days later, the advisor emailed my friend his recommendations. They were exactly what you'd expect to see: a large-cap fund, a small-cap fund, a global fund, a bond fund, and a real estate fund. Each fund demonstrated a history of strong performance relative to each benchmark, and each came from household-name financial firms.
I happened to be there when this email arrived, and I suggested that we take a few minutes and actually read the prospectus for each fund before moving forward. It was at this point that my friend's eyes first widened and then became red with anger.
On the first few pages of each prospectus was a disclosure that the fund would be charging between 0.75% and 1.25% of assets -- on top of the 1% charged by the advisor. Further into the prospectus, we found fee after fee after additional fee. There were transaction fees, regulatory compliance fees, and more. They added up to an additional 1% on top of the other management and advisor fees!
By the end, we joked that the only fee missing was one for "highway robbery."
The math only makes things worse
Taking all the mutual funds together, this advisor was recommending that my friend invest all his hard-earned dollars into a structure that would, in total, charge approximately 3% right off the top every single year. Assuming inflation averages about its long-term trend of 2% per year for the remainder of my friend's working life, these funds would first have to overcome 5% of headwinds in order for my friend to build any wealth in the market.
If the market returned 8% per year on average, then actual wealth would only grow by 3%. That's leaving huge returns on the table.
Fortunately, there's a happy ending to this story
In the end, my friend decided to politely tell this advisor to "go fly a kite." Instead of handing over 3% of his annual returns to advisors and managers, he elected to buy two diversified, low-cost index funds from Vanguard -- one in equities and one in bonds.
What were the total fees, you ask? Just 0.15%, for a savings of 95% today -- and potentially hundreds of thousands in retirement.
The article Is Your Financial Advisor Wrecking Your Retirement? originally appeared on Fool.com.
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