Diabolical Financial Products

financial-diabolicalMerriam Webster’s Dictionary defines diabolical as “of, relating to, or characteristic of the devil.” Unfortunately, there are a quite a few investment products that meet that definition.  They are often overpriced, extremely conflicted, non-transparent and are sold regularly as “suitable” retirement options to gullible investors.

Here are some to avoid:

  • Front-Loaded Mutual Funds. These are usually the “A” shares of a mutual fund. An upfront fee, as much as 5.75%, goes to the brokers, so a $100,000 investment may start with a net value of $94,250.  Generally, these “actively managed” mutual funds will then charge 1%-2% in annual fees on top of this, so long-term underperformance is virtually guaranteed.
  • Proprietary Mutual Funds. These are mutual funds created by the broker.  This is cross selling at its best (or rather its worst).  Brokers extract both selling fees and much of the operating fees.  Furthermore, many of these mutual funds are not publicly listed and therefore tracking performance is almost impossible.  (Yes, non-transparency is wrapped into these mutual funds.)
  • Equity-Indexed Annuities. This is a tax-deferred investment whose credited interest (growth) is tied to an equity index, such as the S&P 500.  However, the upside is typically capped and there is usually a large potential for a substantial loss.  Add in an upfront sales charge of up to 10% and this investment becomes indeed diabolical.
  • Variable Annuities. The average contract cost is 1.5% per year.  And, because it uses actively managed funds, one needs to add another 1% or so to annual expenses.  As a result, there is a 2.5% drag on performance each and every year, at a time when equity returns are expected to be in single digits.  A losing proposition.
  • Non-Traded REITs.   Last week, our blog discussed publicly traded Real Estate Investment Trusts (“REITs”).  http://www.dwmgmt.com/real-estate-investment-trusts-reits/  Non-public REITs, on the other hand, have significantly underperformed their publicly traded cousins.  Four reasons:  Huge (up to 10%) upfront commissions, lack of transparency, higher annual fees, and illiquidity (cannot be turned into cash readily).  Run from these.
  • Hedge Funds. Due diligence is prudent before any investment in hedge funds, given hurdles such as a possible 2% annual fee plus a possible 20% charge on annual profit, along with high minimums and illiquidity.

These diabolical products cost investors trillions of dollars over time in unnecessary fees, which directly reduce performance.  They have been described as “created by foxes, sold by wolves, and bought by sheep.”

Moral:  Avoid diabolical investment products.  Choose low fees, transparency, liquidity and a wealth manager who will act as your fiduciary, always putting your interests first.  And, have fun with the little devils at Halloween.