Mutual funds may be immensely popular among individual investors, but they are also highly inefficient, said Dr. Kenneth Kim, author of ‘Mutual Funds Exposed.’ Kim added that mutual funds suffer from tax inefficiency, hidden costs and high fees.
Americans are losing millions of dollars because investment advisers put them into pricier categories of retirement funds that often pay the consultants for their recommendations.
Now, a Wall Street regulator hopes to stop the losses.
The problem involves mutual funds, a mainstay of retirement plans for many investors. The funds typically have varying share classes, with different fees. Essentially, the same fund can cost you more, depending on your share class, which is indicated by letters such as A, B or C.
Over time, the difference can cost individual investors thousands of dollars each in retirement savings. All together, investment advisers’ conflicts of interest may cost U.S. families $17 billion in cumulative annual losses, a 2016 Obama administration report estimated.
“Having the right share class is a critical factor in ensuring your financial stability at retirement,” said James Langston, president of Fiduciary Integrity LLC, a Frisco, Texas, company that helps people detect and reduce their mutual fund fees. “Waiting too long to find out can cost you.”
The role of investment advisers is crucial. They recommend retirement funds to people who may be confused by all the choices.
But do the advisers always recommend the lowest-cost share class for each fund? Moreover, do they always disclose fees or other benefits they get for putting clients in higher-cost mutual funds?
Judged by recent enforcement actions by the Securities and Exchange Commission, the answer is no — although most investment advisers act in their clients’ best interests.
Since 2013, the Wall Street federal watchdog has announced nearly a dozen actions against investment advisers who placed clients in higher-cost share classes and neglected to disclose fees they received in the process.
Trying to curb such breaches of professional trust and responsibility, the SEC is offering an amnesty program for investment advisers who self-report their misconduct by a June 12 deadline and then promptly repay harmed consumers. In return, the SEC’s Enforcement Division will recommend more favorable settlements for the advisers, including waivers of civil penalties.
“These disclosure failures cause real harm to clients,” C. Dabney O’Riordan, co-chief of the SEC’s Asset Management Unit, said in April while announcing settlements against three investment advisers for breaching their fiduciary duties. The amnesty offer is “part of an effort to stop these violations and return money to harmed investors as quickly as possible,” she added.
The SEC declined to say how many financial advisers have agreed to participate in the program so far.
What should I know about share classes?
They indicate whether you pay a sales charge for your mutual fund, in many cases referred to as a sales “load.” Share classes are typically designated by different letters, including A, B, C, R and I.
If you have a 401(k) retirement plan through your employer, you may have R (retirement) shares or I (institutional fund) shares. These generally don’t have sales loads.
However, if you invest in a mutual fund through a private adviser, you might end up in the A, B, or C share classes, which indicate sales charges. Your investment adviser, in some cases, could have recommended and placed you in the same fund with a different share class that has lower charges.
Check your most recent financial statement and look for the ticker symbol that identifies your mutual fund. The symbol sometimes, but not always, will indicate the share class. Run an Internet search on the ticker symbol, and search for the class.
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How often can you end up in a pricier share class?
No one knows for certain, and the SEC declined to provide an estimate. Some experts characterize the issue as a hidden problem.
“It’s happened thousands of times … but most people don’t realize it,” said Andrew Stoltmann, president of the Public Investor Arbitration Bar Association, whose members represent investors in disputes with the securities industry.
The 2016 Obama administration report estimated that advisers’ conflicts of interest lowered annual returns on retirements savings by 1 percentage point.
Langston, the Fiduciary Integrity executive, offered an example of the impact, based on a $10,000 mutual fund investment for 10 years. The difference between having class C shares and comparatively less costly A shares would be roughly $543, he estimated. The dollar difference would be even greater for larger investments over longer periods, he said.
Your investment adviser should recommend the most cost-effective class shares for your situation, without being swayed by potential conflicts of interest.
What sort of conflicts can lower returns?
Here’s one example, from recent SEC enforcement actions:
The website of Envoy Financial says the Colorado Springs-based investment advisory company specializes in “trusted retirement plans” and “empowers ministers, missionaries, and faith-based organizations to prepare for a lifetime of ministry.”
As of March 29, 2016, the company reported roughly 1,800 advisory clients with roughly $225 million in overall assets.
A September 2017 SEC cease-and-desist proceeding said Envoy Financial recommended and placed clients in Class A mutual fund shares “when less expensive institutional share classes of the same mutual funds were available.”
Envoy Financial’s disclosures said certain mutual funds “may” pay fees to a “dealer,” the SEC said. However, the disclosures did not reveal that the fees paid by the funds the company recommended went to Envoy Securities, the investment advisory company’s affiliated broker-dealer, the SEC said.
Envoy Securities received at least $24,893 in those fees from January 2013 through March 2017, the federal watchdog said.
In a settlement agreement, the SEC imposed a civil penalty equal to the excess fees. Crediting the company’s subsequent actions, the federal watchdog noted that the start of its investigation prompted Envoy Financial to stop recommending the higher-fee share classes, begin switching current clients to lower-fee share classes and give clients rebates or credits.
Envoy Financial agreed to the settlement without admitting to or denying the SEC’s findings. The company did not respond to a message seeking comment on the case.
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How can I avoid overpaying in sales fees?
Start by asking your adviser for more details about mutual fund choices. Here are suggested questions from Langston, the Fiduciary Integrity LLC president:
- What are the funds’ share classes, how much will they cost me, which do you recommend, and why?
- Is there a lower-fee or no-fee share class for the mutual fund I’ve invested in, and how can I switch to it?
- Do any of the share classes I own have contingent deferred sales charges, and if so, what’s the cost?
- What investment time horizon did you note in my account application? (The share class that’s least expensive during a 15-year investment likely won’t be the one with the lowest cost during a three-year time horizon.)
Contributing: The Associated Press
Follow USA TODAY reporter Kevin McCoy on Twitter: @kmccoynyc
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