An X-ray of one affluent, educated and sophisticated investor's portfolio shows how it was chewed up by fees

Helping an ex-Fortune 500 retiree prepare for her appearance before Congress, the author waded through a mountain of paper only to discover that the woman was likely to outlive her portfolio

Sunday 8.11.13 by Guest Columnist Ron Rhoades

Brooke’s Note: This is a true story. It is not an unusual story. But it’s quite unusual for such a bunch of dirty details about systematic, pedestrian investor abuses to surface in public. It shouldn’t be and at least we have this one. It took courage for Janet to testify in Congress with these details. It took Ron’s energy, will and everyday courage to bring the story to a much wider audience with his writing of this article. Thank you, Ron.

Having retired about a decade ago from a Fortune 500 company, Janet Stetson (a real person now in her early 60s, although for confidentiality reasons this is not her real name) was faced with taking a lump sum distribution from her defined benefit plan, to be rolled over into an IRA. In addition, Janet, who is single, had other savings. Together with future receipt of Social Security benefits, this seemed more than enough to handle her financial needs in retirement — which could last 30 or even 40 years, based on her good health and life expectancy upon her retirement. See: How a suddenly wealthy, young Bay Area widow found her RIA after months of fruitless efforts.

Janet did all the right things. She asked around — family and friends — for financial advisors to interview. She interviewed several. In the end, she chose one of the largest wealth management firms and a team of financial advisors with fancy titles, such as “senior VP — wealth management.” She received the firm’s Form ADV Part II (now known as Part 2A), and received a broad variety of investments.

“How much do I pay in fees?” Janet inquired of her current financial advisors. The reply: “0.85% each year,” which according to Janet was the answer she received on several different occasions, with no elaboration and no caveats. See: Why only 14% of RIAs volunteer complete pricing information to clients and why selective fee disclosure is not a winning strategy.

Janet was happy. She was, in fact, represented by “investment advisers” bound to act in her best interests, so she understood. Yet, it did not seem her portfolio was growing as fast as the overall market, especially in recent years.

Enter the expert

In the late 1990s, Janet had been involved with the Pension Rights Center, a non-profit advocacy group for retirees relating to conversion of her employer’s pension plan to a defined-contribution plan. In July, through that non-profit, she was asked to testify in front of a congressional panel about her experiences with her fiduciary advisors. As her testimony was being coordinated, an executive of the non-profit reviewed her monthly portfolio statement, and became concerned that she had expensive products.

That’s where I came in.

Two days of reviewing disclosure documents

I was brought in as an expert to discern her “total fees and costs” and undertake a general portfolio review. Janet thought she was being taken care of appropriately — and her testimony was going to reflect the fact that she had chosen fiduciary advisors and that she was pleased with them. After my analysis, the focus of her testimony changed.

As I undertook my analysis, I reviewed the large firm’s current Form ADV, Part 2A. I searched the Web (including at times the Securities and Exchange Commission’s Edgar database) and reviewed an additional 40 other disclosure documents, including fund prospectuses, statements of additional information, a variable annuity prospectus and occasional fund annual reports. I also obtained summary data from Morningstar Inc. See: Review: What the SEC did right and wrong with the redesign of its website.

Over the course of the two days available to me to undertake the analysis, I pored through the monthly statement that was nearly 60 pages long (not uncommon, given the existence of four separate accounts and a broad range of investments). It included cost basis information, realized gains/losses, unrealized gains/losses, transaction ledger for the month, etc. Most of the documents I reviewed — prospectuses, statements of additional information and annual reports — were between 30 and 150 pages in length. Fortunately, I knew where to look to access the data I needed. As a professor teaching advanced courses in investment planning, retirement planning and insurance, I possess a very good understanding of all of these documents, and the terminology utilized. As a tax and securities law attorney, I understand the legal structure of the documents. I was hence able to obtain much of the data I needed from these disclosure documents, in a very rapid manner — relative to most financial advisors (I suspect). And certainly a great deal faster than 99% of individual investors.

What was the result of my analysis? Here’s where the tale begins to turn ugly.

The fees and cost analysis

First, understand that a vast portion of Janet’s portfolio — more than 80% — was in two IRA accounts, both managed under investment advisory programs. (This is where the 0.85% annual investment advisory fee was assessed.) Janet had two other brokerage accounts with this dual registrant firm (i.e., both as a broker-dealer and as an investment advisor), which were also reflected in her consolidated monthly statement.

Second, I found that 24% of Janet’s account was invested in a variable annuity possessing total fees and costs of 3.75% annually. (The investment advisory fee was not applied against this investment.) While the variable annuity had a stepped-up death benefit guarantee, and a guaranteed minimum income benefit rider, I concluded that the high costs of the product and the limited nature of the benefits of these riders made the benefits to Janet largely illusory in nature.

Third, the broker-dealer, and its financial advisors, received way more compensation than the 0.85% annual amount they stated to Janet. They received “revenue-sharing payments” in the form of 12(b)-1 fees. Most of the mutual funds in the investment advisory accounts had 12(b)-1 fees in the range of 0.25% to 0.15% annually. One mutual fund in the brokerage account had a 12(b)-1 fee of 1% annually. While I cannot be certain that all of these 12(b)-1 fees were passed on by the funds to the broker-dealer firm, a frequently quoted statistic is that 80% of 12(b)-1 fees are, in fact, paid to broker-dealers. See: After years of DOL bluster, new 401(k) rules appear to make RIAs’ low expenses look higher than those of brokers.

Other revenue-sharing payments were noted in the funds’ prospectuses, including payments for shelf space. These are payments by fund complexes for “preferred marketing opportunities,” often paid by the fund’s manager from a portion of the management fees charged by the fund’s investment advisor. The existence of such payments provides an incentive to a fund manager to establish and maintain higher management fees, even as economies of scale are achieved as the size of the fund increases. Again, it was not possible to discern if revenue-sharing payments were actually made, but Form ADV Part 2A of the dual registrant firm noted that the firm “receives other compensation from certain distributors or advisors of mutual funds” and that “revenue sharing compensation will not be rebated or credited” to its clients.

Additionally, many of the mutual funds in Janet’s portfolio provided “additional compensation to registered representatives of dealers in the form of travel expenses, meals, and lodging associated with training and educational meetings sponsored.” Whether these particular benefits were actually received by these particular “financial advisors” is not known, although such practices remain fairly common in the broker-dealer industry.

Also, for trading of securities within the fund, many of the funds paid brokerage commissions back to the dual registrant firm at which Janet held her investment advisory accounts. The generally high portfolio turnover of these funds resulted in a relatively high amount of brokerage commissions (and other transaction costs within the funds, such as principal mark-ups and mark-downs, bid-asked spreads, market impact costs, and opportunity costs due to delayed or canceled trades). Additionally, the amount of brokerage commissions in many of the funds was higher than would be expected, due to the payment of higher brokerage commissions by the funds in return for research from the broker-dealer firm — a practice known as payment of “soft dollars.” See: RIAs need to take a hard look at their use of soft dollars.

The dual registrant also had Janet invest in one of its proprietary funds. Of course, this fund had high fees and costs, as well. I could not discern if any of the management or other fees were rebated to the client.

In summary, I found that Janet was paying above 2% in “total fees and costs.” With another day or two of analysis, to better discern and analyze the data on transaction and opportunity costs (including those relating to cash holdings in the funds, which were above average in many cases), I would likely find that the total fees and costs ranged somewhere between 2.1% and 2.5%, and perhaps even higher.

To provide some context, the average investment advisory fee paid for an overall investment portfolio of this size would be slightly below 1% a year. And, with the fiduciary advisor avoiding additional compensation and utilizing both low-cost and tax-efficient (where appropriate) investments, the additional fees and costs would be quite modest. In essence, Janet was paying about twice what she should have been paying, in total fees and costs. And there are, as I pointed out to Janet, many financial/investment advisors who charge fees well below industry averages, and who also recommend very-low-cost mutual funds or ETFs to their clients. See: The basic ETF trading practices that can save your clients money.

Contrary to the understanding of many individual investors that “expensive investment products must be good,” the high total fees and costs incurred by Janet were certain to drag down the performance of her portfolio over time, and by a large amount due to the effects of compounding of annual fee payments, and its affect on the resulting end values of a retiree’s portfolio.

Tax efficiency: Not present

Other aspects of Janet’s portfolio were troubling. The overall portfolio was not designed in a manner that boded well for long-term tax efficiency. The location of assets, as between taxable and tax-deferred accounts, did not appear to reflect any long-term tax minimization strategy. See: Structuring to optimize tax-efficiency.

By way of explanation, as a general rule taxable accounts should hold assets that will secure long-term capital gain treatment upon their sale, such as tax-efficient, tax-aware or tax-managed stock mutual funds. Also, international stock fund allocations to taxable accounts can result in income tax credits; these tax credits are not available for international funds held in IRA accounts. In tax-deferred accounts, fixed-income investments should initially be allocated. The Roth IRA account, which grows tax free, should be held in the asset class with the greatest long-term expected returns, such as U.S. small-cap value stocks These are general rules, only, and there are some exceptions to these rules, none of which appeared applicable here. For example, some advisors might hold a portion of equities in tax-deferred accounts, in order to permit a “tax-free rebalancing” to occur — at least once or twice — if equities return substantially more than fixed-income investments following the initial structuring of the portfolio.

However, since the bulk of Janet’s overall investment portfolio was in IRA accounts, the effects of this inattentiveness to tax-efficient investing were somewhat ameliorated. If the investor had possessed a somewhat larger percentage of the portfolio in taxable accounts, the concerns expressed herein as to tax-efficiency would be much greater.

Investment strategy: Was there one?

In the review of the investment portfolio I did not perceive any overall strategy. Perhaps the overall investment strategy is contained in a separate document. Probably not, however, as Form ADV, Part 2A of the dual registrant firm are expressly excluded from the investment advisory programs in which Janet was enrolled.

As to the equities (stocks, stock funds), there does not appear to be, overall, nor within the funds surveyed, a commitment to the utilization of investment strategies that have withstood academic scrutiny. These include utilization of the value and small-cap effects (part of the Fama-French three-factor model. See: Dimensional’s co-CEO tells clients at Monterey event that DFA is changing its Classic-Coke intellectual fund recipe.

Instead, within the portfolio was an emphasis on individual stock selection, or active management. As the academic research has shown, active investment strategies underperform, on average, passive investment strategies over long periods of time. (For a good explanation of this issue, without needing a heavy dose of statistics, see “Rick Ferri’s recent article”:

The portfolio had a great many different funds, but this did not mean that proper diversification was achieved. (It is possible to achieve a very high level of diversification from a handful of funds, if properly selected.)

I would note that two-thirds of Janet’s portfolio was invested in fixed-income securities of some form. While this might sound conservative, the presence of number of high-yield bonds in the various funds, a floating-note fund, and a structured fund investing in mortgage-backed securities of dubious quality (the fund was the subject of a class action settlement, in this regard, in 2009), presented obvious risks.

Janet was withdrawing 3.5% from her investment portfolio annually, and she expected this rate of withdrawal to continue. Yet, given the high fees and costs of the overall investment portfolio, and its present asset allocation, I projected that the portfolio would likely only sustain (with its current asset allocation) a rate of withdrawal of approximately half the current amount. In other words, Janet was likely to outlive this portfolio, the way it was currently structured, and given its high fees and costs.

I would note, however, that I did not know many facts which, if I were Janet’s advisor, I would like to know to complete my analysis and to provide recommendations to her. I did not sit with her for hours to explore her lifetime financial goals, values, history of reliance on professionals for advice, and many aspects of her financial situation. I did not review her personal expenditures budget, other assets and debt, and other risks to which she might be exposed in all aspects of her financial life. Hence, the focus of my analysis was limited — a fact noted in my report to Janet. See: Why you won’t know your female clients are unhappy until they’re out the door.

Additionally, since I was provided with only a snapshot of Janet’s portfolio, I could not see the changes to the portfolio made over time. However, based on the purchase dates of many of the investments stretching back years it did not appear that a great deal of changes had been made to the investment portfolio.

Yet, even with these limitations, I was able to discern that Janet was being harmed, by a high level of fees and costs, a questionable asset allocation, and a somewhat tax-inefficient portfolio. And, while the precise amount of additional compensation paid to the dual registrant firm and its “wealth managers” will likely never be known, it is certain that insidious conflicts of interest were present — which no doubt affected the quality of the “advice” being provided.

Janet goes to Congress

The hearing took place on July 8, in a hearing room in the House of Representatives’ Cannon Office Building. AARP and other non-profit organizations organized this informational session for House staffers. The room held about 100 or so, and there was literally standing room only. I found myself in a panel presentation in an overflowing committee room, providing information to congressional staffers about the fiduciary standard of conduct and the importance of its potential application by the SEC and Department of Labor.

Janet was the second-to-last panelist to speak that day (I was the last.) Despite the fact that she is extremely self-confident and articulate, her voice was cracking as she related her experiences. “I feel … betrayed.” She related that she had often confirmed the fees which she was paying, by asking her “financial advisors,” and that she was repeatedly informed of a figure that was far less than what she was actually paying.

Janet continued, and with sad eyes, and anger apparent in her voice, she related to those present: “I trusted my financial advisors. I thought they were looking out after my best interests. I was wrong.”

When Janet finished her comments, it was my turn. Rather than exploring aspects of the fiduciary standard, as I had planned, I instead decided to ask Janet some impromptu questions. “Janet, if I may call you that … did you receive the Form ADV, Part 2 from the firm, and over the years did you receive the mutual fund prospectuses and annual reports? Did you read them and did you understand them?

Janet was a little taken aback by my question, at first. But, only a moment passed as she thought about it, and succinctly answered, “yes, and no.” As we explored what she meant, it became obvious that she had received the documents. Despite her level of education — well above the average of most individual investors — she did not understand them.

Janet continued. “I trusted my financial advisors. They were supposed to be honest with me. I asked them direct questions. At no time did they explain to me that either they or their firm received additional fees.”

Familiar tale

I then related, as a panelist, to those congressional staff members present, that Janet’s tale is by no means an isolated one. The financial services industry is full of “financial advisors” and “wealth managers” and “investment consultants” and “financial planners” who possess multiple layers of conflicts of interest. In fact, I estimate that 95% of “financial advisors” don’t avoid nearly all conflicts of interest, as they should. And the disclosures of conflicts of interest, when made by dual registrant firms and their employees, are often “casual” in nature, are not read by investors, and even if read are very seldom understood. See: Why you should pay attention to proliferating advisor credentials.

The panel discussion continued, and we answered a great many questions from the interested staff members there. We explored how plan sponsors (small- and large-business owners) are being increasingly sued for breach of their fiduciary duties (imposed by ERISA) after receiving conflicted advice from non-fiduciary “retirement plan consultants” and providing only high-cost funds to the qualified-retirement-plan sponsors. We further discussed the all-important decision of whether to roll out of a defined contribution plan upon retirement, and how much marketing by large financial services firms was directed at this life event. See: What a wave of 401(k) lawsuits tell us about what RIAs really need to worry about.

The panel concluded, but Janet was not yet finished. She spoke up, stating, “Don’t let what happened to me keep happening to others. It’s up to all of you … make certain each and every financial advisor out there acts in the best interests of their clients.”

Roller coaster of emotions

In the days following the hearing, as I worked through the analysis and uncovered conflict of interest upon conflict of interest, I myself became both angry — and sad.

We know that “dual registration” (i.e., registration as both a broker-dealer firm and as a registered investment adviser firm) has become increasingly common. We also know that about 88% of investment adviser representatives are also registered representatives of broker-dealer firms. (Of the remaining 12%, many of them also possess insurance licenses.) See: Should I dump my securities licenses?.

I know that Janet’s “wealth management” firm possessed fiduciary obligations to her, as did the team of “financial advisors” working for that firm.

But … is this what the fiduciary standard has come to? Has it now become permissible to not candidly discuss with clients all of the compensation either the financial advisor or firm receives — especially when asked? Why do firms rely upon complex written disclosures (even then, “casual disclosures” which don’t quantify compensation amounts received) — when we have substantial academic evidence that investors don’t read the disclosures (due to many behavioral biases, which have long been studied and discerned by academia)? Even those that try to read disclosure statements, like Janet, rarely understand them.

I woke up a few mornings later to find the Securities Industry and Financial Markets Association (Wall Street’s lobbying arm) again touting a “new federal fiduciary standard.” Yet, as evidenced by SIFMA’s statements, this is nothing like the true fiduciary standard found under ERISA’s “sole interests” strict standard, or even the modestly less strict “best interests” fiduciary standard found in the jurisprudence of the Investment Advisers Act of 1940 (as I recently explained, on behalf of The Committee for the Fiduciary Standard, in a July 5, 2013, comment letter submitted to the SEC). See

How do I feel today, after my experience on Capitol Hill?

I am embarrassed — to call the “financial advisors” who advised Janet my “colleagues.”

I am angry — that we permit such harm to come to hundreds of millions of our fellow Americans, by not applying the fiduciary standard properly.

I am distressed — that, in the face of huge amounts of cash flowing to Congress from Wall Street — and other sources of influence exerted upon both legislators and (some) agencies and their staffs — that the prospects for a bona fide fiduciary standard appear so dim. See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.

I am saddened — that we are unlikely to see, in my lifetime, if the current course holds true, the application and enforcement of a bona fide fiduciary standard upon all providers of personalized investment advice and financial planning advice.

I am disappointed — that I will likely not be able to hold my head high someday and say, “I am a member of the honorable financial advisory profession. We provide expert personalized financial and investment advice which in our clients’ best interests at all times. We receive professional-level compensation, as should be afforded to our high level of expertise. We serve our clients with value-added services. More importantly, we promote, though the trust placed in our services by our clients, capital formation and the resulting U.S. economic growth which follows. As members of a true profession, we answer to a higher calling. We serve the public interest.”

What now?

I think about the profession, and where we might be headed, a great deal.

Is it worth the ongoing battle to try to counter the huge amount of lobbying that Wall Street undertakes in the halls of Congress, and at the SEC? Is it worth trying to effect a fiduciary standard for all providers of personalized financial advice which is not watered down by Wall Street to some type of casual disclosure-only standard, which is not — in any way, shape or form — a true fiduciary standard at all?

I wonder if we should instead, at some point, turn our efforts toward developing our own professional standards of conduct. Why should we rely upon regulators — most of whom have never served individual investors under a true fiduciary standard — to define fiduciary standards for us? Should we, instead, formulate a voluntary set of true fiduciary standards, and see who is willing to adhere to same? See: What the 8 pillars of a FINRA-replacing entity for RIA oversight look like and how personal accountability is key.


In the end, I am frustrated, confused, and — to an extent — demoralized. What if, after all these efforts, over the past decade, by many well-meaning leaders of our emerging profession, we end up with a new federal fiduciary standard, which is nothing more than the extraordinarily low suitability standard with some additional disclosures (casually made in a non-affirmative manner, designed to ensure that clients don’t understand the disclosures, and found hidden away within some long disclosure document or in a dark corner of some website which consumers must search out, discover, read, and seek to comprehend)? See: FINRA is making dog whistle comments hinting its SRO ambitions still simmer.

The late, great Justice Benjamin Cardozo — and many other jurists – will roll over in their graves if, as I suspect might occur, SIFMA’s “new federal fiduciary standard” is adopted by regulators. The “particular exceptions” of which Justice Cardozo so eloquently warned will swallow up the substance of the standard itself, leaving us with continued consumer confusion and disgust. See: New York conference: SIFMA wants members to be like RIAs — minus the same rules of accountability.

What are the consequences if Wall Street wins and our fellow Americans — and our clients — lose these battles? Won’t the financial and retirement security of my fellow Americans continue to be denied through Wall Street’s extraordinarily high extraction of rents? Won’t this continue to result in large burdens upon our governments, as they seek to provide essential services to our Americans who are so poorly prepared for retirement, precisely at the time when governments can ill-afford such burdens?

Will not the failure to limit Wall Street’s excessive diversion of the returns of the capital markets, away from the true intended beneficiaries of those returns — American investors — continue to constitute a huge drag upon much-needed capital formation, increasing the cost of capital to all U.S. business, and acting as the dragging anchor that slows the progress of the ship which is our nation’s economy?

What will happen to the Janets of the world? Who will finish Janet’s tale? Will this tale continue down the path of a Shakespearean tragedy?

What will happen to the “profession”? Will it become a true profession, or just an excuse to fleece consumers?

Finally, who will join with many others, and say to Congress, the DOL and the SEC “We must have a true, bona fide fiduciary standard for all providers of personalized investment advice. We must restore trust in our financial system. We must achieve a true profession, founded upon and informed by the highest standard of conduct under the law, which serves not Wall Street but instead, properly, the public interest.”

Ron Rhoades, JD, CFP® serves as chairman of the Steering Committee of The Committee for the Fiduciary Standard. He is an assistant professor of business law and financial planning at Alfred (N.Y.) State College.

Ron Rhoades