Money for nothing: Some investors pay for advice they never get

Sam in Boston built his mutual-fund portfolio years ago but has long since stopped working with the financial adviser who set it up.

Renee in Santa Barbara, Calif., hasn't worked with an adviser for years, since hers retired. Alan in Colleyville, Texas, bought a mutual fund years ago on a cold call from a broker. The fund investment turned out fine, but the broker quit the financial-services business a short time later.

What these investors have in common is that they have stuck with funds even though they no longer work with the adviser. Moreover, all three believe that, because they have no adviser currently, they're not paying for the assistance of an adviser.

They're wrong.

Many investors are unaware that they are paying advisory fees for services they're not getting, on funds purchased years ago from advisers long out of the picture.

It's hard to imagine that you could pay for a service and not know it, but it happens all the time. Here's how:

Many funds sold by advisers carry a 12b-1 fee — for sales and marketing — which is part of the fund's total expense ratio, but is earmarked for the "distribution costs" of the fund. In plain English, some of the money acts as a "trail commission" and is paid out to the adviser over time, in perpetuity.

How it works

If the customer drops the adviser but hangs on to the funds (Sam), or if the adviser quits or retires (Renee and Alan), or the relationship simply grows apart for any reason, the fee remains in place. It is collected and paid out. Even if the broker/planner is fired, the fund will continue to pay the fee unless the adviser resigns the account or the firm is notified to make a change on the "adviser of record" for the account.

The answer, however, isn't as easy as dumping the adviser and saving the fee. If there is no named adviser of record, then the fund either pays the brokerage firm or you become a "house account," where the trail commission stops, but the savings is spread out over all of a fund's accounts.

A few fund firms, such as the Selected American funds, have a class of shares without a 12b-1 fee, where an investor can make a tax-free swap into that share class if they have fired the adviser, but those cases are the rarity, not the rule.

Investors do have several choices. Obviously, they can pick funds without 12b-1 fees, which is common for self-directed investors who aren't working with an adviser (though it's worth noting that there are plenty funds that have no 12b-1 but that still have low total costs. It's total costs — rather than who gets the nickels and dimes — that matter most). Sam does that now, for example.

The 12b-1 fee is not the stupid part. Plenty of people want and need financial help, and advisers who provide that assistance deserve to be paid. A fee that goes to advisers for continuing service is fine, provided that the service is delivered.

The big problem

The problem is that customers like Sam, Renee and Alan are paying for help that they are not getting.

"You may be happy with the funds, you may not want the help, but you are paying for it," said industry consultant Geoff Bobroff of East Greenwich, R.I. "What's really stupid is paying a fee and not attempting to get service, because it can be obtained."

That doesn't mean a guy like Sam should start buying high-load funds again. Nor does it mean that Renee will find that her portfolio needs an overhaul.

It does mean they should contact an advisory firm and inquire if they can get a portfolio checkup in exchange for making someone at the firm the new "adviser of record" — directing the fees they already are paying to the new firm/adviser. If they are comfortable with the advice, they can decide to pursue it.

Right now, they are paying for nothing, and the dollars are adding up. On a $100,000 portfolio being charged 12b-1 fees of 0.25 percent, the fees amount to $250 per year. Even if they decide not to follow the new advice they could get, they should at least get something for their dollars.

Most fund firms have a simple one- or two-page form that allows an investor to move their account to a new brokerage, or to simply designate a new adviser of record at the same firm. They will also typically refer customers whose adviser is no longer servicing the account to someone who will, although you have to figure they're not referring you to an adviser who would sell the family's funds, even if that might be the best move.

Said Bobroff: "If they like the funds they are in, they should recognize that they are paying for that advice and service. Why not go ahead and get something for it?"

Chuck Jaffe is a senior columnist

at MarketWatch.

He can be reached

at cjaffe@marketwatch.com

or Box 70, Cohasset, MA 02025-0070.