How Financial Advisors Sell Mutual Funds

BACKGROUND

Financial advisors are in a unique position of trust. However, that trust is often taken advantage of. One of the most offensive ways advisors do so is by fooling clients into thinking they have some sort of magical process for putting together a portfolio of mutual funds. Advisors convince clients they spend enormous amounts of time analyzing different funds and use language such as “Alpha”, “Risk Adjusted Return”, or my favorite “Upside / Downside Capture Ratio” to demonstrate how smart they are. The end goal is the client should feel like there’s no way they could do it on their own, or God forbid that there might be a better way to build smarter portfolios. It’s a bummer because clients trust, look up to, and sometimes even admire their advisors! 

WHAT ACTUALLY HAPPENS

You sit down with the financial advisor, and they say something like “Fund ABC should be replaced with Fund XYZ because the fund didn’t… blah blah blah ___insert whatever garbage sounds convincing here___”.  You agree with the advisor’s astute assessment, thank them for their exhaustive research, and happily refer your friends and co-workers. What actually happened was prior to your review appointment the advisor had lunch with a sales rep from the mutual fund company (not on the advisor’s dime of course), and the rep convinced the advisor to use his mutual fund. In exchange for using his fund in client accounts, the advisor receives marketing dollars from the mutual fund company. The advisor may have attempted some due diligence on the fund, but when they realized the fund was expensive or didn’t beat its benchmark over the long haul, they cherry-picked a time frame or other metric and used this as the basis of their recommendation. Unfortunately, this is how financial advisors sell mutual funds.

WHY THIS BEHAVIOR IS TOTALLY ABSURD

The reality is that the vast majority of fund managers financial advisors recommend can’t get it right, so how can a financial advisor possibly build a smart portfolio of mutual funds that are in a client’s best interest? It would require an advisor to not only pick a fund manager that in the future is going to perform well, but then that mutual fund manager would have to pick the right stocks and bonds within the mutual fund they run! How can a financial advisor consistently pick the right picker? Newsflash: your financial advisor is not Marty McFly from Back to the Future, nor do they posses some futuristic almanac showing tomorrow’s investment results today! What’s even more insane about this whole issue is the whole basis for the fund recommendation is based on something that already happened. Duh, everyone is brilliant with hindsight’s benefit! You wouldn’t drive around town by looking in the rear view mirror all the time, so why should you believe an advisor is doing you right by touting some arbitrary performance figure to hook you in on outdated information that happened yesterday? 

WHAT TO DO ABOUT IT

Instead of driving your portfolio in the rearview mirror AND trying to beat the market, work with your advisor to build a diversified portfolio with low cost investments like ETFs and index funds. Don’t be surprised if you get some pushback, and don’t let them talk you into sticking to their expensive mutual fund agenda. If you can’t work towards a resolution, it’s time to find a new advisor. Hints: pick one that doesn’t sell products for commissions, doesn’t accept mutual fund 12b-1 fees, and one that integrates a financial plan into your overall situation. You will save truckloads in investment fees, and you’ll end up with a smarter portfolio.