But Where Are The Clients' Yachts?

We recently looked at a new client's IRA holdings. Raymond James was the brokerage firm. When I opened up the statement and looked at it, I was quite stunned by the mess I found. The IRA was down 42.5% in 2008. Fortunately for the client, the account managed to clawback 13% YTD thru July 31. However, given the heavy overweighting of the fund in small-cap stock funds, the best index to compare this portfolio to would be the Dow Jones Small Cap Index, which was up 17.6% YTD thru 7/31. So the broker is taking excessive risk with his sector selections, and the performance of the fund lags its benchmark index by a considerable amount.

What I found particularly horrifying was that roughly 50% of the fund was put into mutual funds with a 5.75% up-front load (commission). In addition, several of these funds with up-front commissions also carried very large ongoing management and expense fees. In other words, broker commissions and mutual fund fees are eating this account alive. One of the funds, a Pimco commodity-based fund, actually has 71% of the fund in Treasuries and agencies (mostly Treasuries). Why on earth would anyone volunteer to pay 5.75% UP-FRONT to invest in a fund that is mostly U.S. Treasury bonds? Not only that, the fund also charges a marketing fee (12b-1) and has a high expense ratio (1.24%). Talk about an investment which typifies the old question: "but where are the clients' yachts?"

Just as bad as the high fees was the way in which the portfolio was invested. The sector selection was rediculously overweighted in the small-cap sector. In fact, this IRA account represents a high percentage of the client's net worth, and is thus inappropriately diversified into risky stocks. To begin with, there were 17 different mutual funds, most of which were some form of small cap/mid-cap fund. There was a very high overlap of the same stocks listed in the top 10 holdings of these funds (the usual suspects - Microsoft, Dell, Cisco, Apple, Google, etc.) Anyone who has studied portfolio theory knows that a portfolio with 17 mutual funds has absolutely no chance in hell of outperforming the stock market.

To be blunt, for all the fees Raymond James is sucking out of this IRA account, Raymond James is providing absolutely ZERO in the way of value-added money management skills. The client would be better off having the account invested in the SPY ETF (S&P 500 ETF which replicates the performance of the S&P 500 with almost no fees).

Why is the client paying a lot of money for Raymond James to manage this account? Answer: because Raymond James knows that the client is unsophisticated in investments and has no clue that these kinds of fees are being charged, that the fund is vastly underperforming comparables on a risk/return basis AND that there are many low-fee alternatives.

This IRA fund is nothing but a "killing field" of fees with no regard for risk or performance. Quite frankly, I could not sleep at night knowing that I had clients with a substantial portion of their asset-base invested inappropriately and in a way which is designed to skim a high degree of fees off of the account. We have found this story to be quite common, especially where the financial advisor works for a big bank/brokerage like JP Morgan, Citibank/Smith Barney,Wells Fargo/Wachovia, Raymond James, A.G. Edwards as well as with "independent" registered advisors like LPL Financial.

The moral of the story is that everyone who is reading this and does not manage their own money needs to sit down with an "outside" independent financial advisor with a lot of experience, and a reputation for being ethical, who can go over how their account is currently being invested.