Are Your Funds Actively Managed?

Posted by Michael Milam on Sep 5, 2014 5:54:00 PM

Are-Your-Funds-Actively-Managed-fbAs I work on new client’s personal financial planning, I am always disappointed in how the rascals in the wealth management business take advantage of their clients. We are constantly working with clients to make sure they have a plan that fits and that such a plan is actually being followed.

Case in point, recently we were reviewing a new client’s previously setup investment strategy. The client has over $3 million under management. With their previous financial planner, this client stated they wanted to avoid paying too much in fees for asset management.

Problem 1 – “Hidden” Fees

The client’s financial planner put her into C share mutual funds. The fee structure in a C share mutual fund does not disclose the fees on the client’s monthly or quarterly portfolio statement but rather in the annual prospectus. Often times, the client does not read the prospectus or notice the fees stated therein. This client was happy because she did not see the fees. But in reality the fees were just discretely placed in the annual prospectus.

C Shares 

C shares are a type of mutual fund share.  C shares are one of many types of different expense arrangements of mutual funds. The main difference between the types of shares is their fee (load) structure. C shares have a level fee or level-load structure. This means that the full amount is invested in the mutual fund but there is an annual percentage fee. The fee is typically paid monthly but does not show up on the client’s monthly statement. 

This is how the fee is usually assessed.  Assuming a 1.2% annual fee that comes out on a monthly basis and a 8.2% net rate of return for the year; the client would see and get 7% net rate of return listed on their annual statement and no deduction for fees. The fee would be already taken out in a monthly payment of .1% per month (1.2% / 12 months). This is how a client can be led to believe that they are not paying a fee for their C share mutual funds, but really are. The client would have to read through the annual prospectus to find this fee, which doesn’t often happen.

Worse, with C shares, if the fund incurred a loss for the year of 8.2%, then the fee would still come out and the loss would be 9.4%.


Problem 2 – Advisory vs. Brokerage

Now it is best to understand the difference between an advisory account and a brokerage account.  Under an advisory account the manager (financial planner) is paid a percentage of the fees under management. This is usually paid quarterly and the manager is required under industry rules to show they did something to manage the account at least once a year (more on that subject in future articles). Under a brokerage account, the manager is not required to show any movement of money.

C shares are sold in a brokerage account, so in our client’s case, the financial planner was not required to work on it once the C shares had been sold to the client. Also, with C shares, there is typically a 1 percent penalty if the shares are sold within 12 months. That 1 percent is on top of the C share mutual fund fees. In our experience, 9 times out of 10, financial planners who put their clients into a C share fund do not actively manage the account.

What seemed to our client as a great no fee investment strategy was actually costing her more than going with an advisory type account. Unfortunately, this is a common situation that we come across as we review a new client’s financial plan.

C Shares Have A Place (But Not For This Client)

With amounts less than a few hundred thousand dollars using C shares might be appropriate.  However, a portfolio over $500,000, or $3 million as in this case, should be actively managed. This C shares investement strategy were a clear sign that previous the financial planner was not working on the client’s behalf. 

The Ideal Portfolio Management

The ideal way to manage a portfolio is to maintain a proper allocation of funds to meet a client's well delineated risk tolerance or aversion characteristics. With age and changing client objectives, individual risk parameters change. Your financial planner should review the portfolio construction and make appropriate adjustments, if needed, at least every 90 days. This would be an advisory account. 

Key Takeaways

Don’t be fooled by unscrupulous financial planners.

1) Get solid recommendations for financial planners from sources you trust.

2) Double-check the proposed investment with your CPA or business advisor. Your investment strategy is so important to your future financial well being that it should warrant at least a second opinion.

3) Understand that fees are only one factor that determines your overall net rate of return.

If you have any questions on your financial plan, comment below or contact us.

Financial Coaching - Productivity: Measurement & Improvement   


Michael Milam, CPA, CGMA, MAcc, is a founding partner of Milam, Knecht & Warner, LLP. He regularly speaks and publishes articles on tax and estate planning.

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Tags: Investments