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Lately, the press has focused
on the Mutual Fund Late Day-Trading Scandal. But there is
another scandal that could have had a much greater impact on
your investments. The NASD estimates that “investors did not
receive discounts in approximately one out of every five
transactions that were eligible for discounts.”
This scandal has to do with consumers being cheated out of
the breakpoints they’re entitled to when buying
commission-based mutual funds. To better understand this
problem, you first have to understand your choices. One
choice is to pay all the commission up-front (A shares).
Another is to pay it through a surrender penalty if you pull
your money out of that fund within 7 years (B shares). B
shares have higher internal fees so that you end up paying
the fund company back even if you stay in the full 7 years.
Regardless of when you pay, the broker gets paid right away.
Most people are not aware that mutual fund companies allow
you to pay less commission up-front when you invest more
money. For instance, a typical commission-based fund family
charges an up-front commission of 5.75%. But if you invest
$50,000 or more in that mutual fund family the commission is
reduced. The more invested, the less commission percentage
you pay. Invest $250,000 and the commission drops to 2.5%.
This is called a commission breakpoint and is available on
the up-front, A shares option.
On the other hand, there are no breakpoints on the B shares
option. The result is that if you invest more than $50,000,
the broker has a financial incentive to sell you B shares
instead of A shares. They make more money because you are
overcharged and most times you don’t even know it.
Brokerage firms are supposed to have internal controls to
prevent brokers from over-charging clients by selling them
the wrong share class. Typically, a brokerage firm will
limit ($100,000) how much can be invested in B shares. This
is sort of like trusting the fox to guard the hen house,
though, because if the broker makes more money so does the
brokerage firm.
Brokers have found other creative ways to overcharge their
clients who purchased mutual funds. They may recommend A
shares for some money and B shares for the rest. Or they can
spread the money between several mutual fund families so
that you don’t earn the breakpoints you would get if all of
the money was invested in the same mutual fund family.
It is very difficult for the average investor to know how
much they were charged. Your purchase confirmation doesn’t
show how much you paid in commission. Very few people read
the prospectus to see if breakpoints are available. Most
don’t understand the difference between A and B shares and
rely on their broker to decide which is best.
The NASD tells you to ask yourself these questions to see if
you might be affected: 1) Have I purchased a mutual fund
with a front-end sales load? 2) Have I purchased additional
funds in the same fund family? 3) Have close family members
purchased shares of this fund or fund family? 4) Is the
total of these purchases together greater than $25,000?
The process to find out if you have been overcharged is
involved. For A share purchases, compare the price you paid
with that day’s Net Asset Value price. The percentage
difference is how much you paid in commission. The
prospectus will tell you any breakpoints you were entitled
to. You’ll also want to see how much you invested in other
fund families, and if you would have received a better
breakpoint if you had stayed with the same fund family. For
B share purchases, one red flag is if you purchased $100,000
or more.
Of course, the best solution is to avoid paying commissions
altogether. Some advisors work the way I do, where instead
of paying commissions, clients pay an ongoing fee based on
their account’s value. In the industry, this is referred to
as being a fee-based advisor. This way you know exactly what
you’re paying and you keep maximum control and flexibility.
If you have suspicions, it may be worth paying your
accountant to check it out for you. The NASD requires firms
to refund discounts if they were never paid. If you would
like my help call toll-free 877-827-1463 or email me at jeff@guardingyourwealth.com.
You can also find out more by reading the Investor Alert at
www.nasd.com.
Mr. Voudrie is a Certified Financial Planner and President
of Legacy Planning Group, Inc., a Private Wealth Management
Firm in Johnson City, TN.
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