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Be Leery of These Financial Products

Roger Wohlner

Just because you can buy a particular financial product doesn't mean that you should. Here are several that you should at least be leery of and that you might consider avoiding altogether.

High-Cost Variable Annuities

I'm not a huge fan of variable annuities. My issue is not so much with the product as with the high fees associated with far too many of the variable annuities sold in the market place. A variable annuity entails a either a single lump-sum or a series of investments into sub-accounts, which are somewhat like mutual funds. There are equity sub-accounts, bond sub-accounts and so on.

I've seen contracts with annual expenses well over two percent. In my mind this is beyond outrageous and really eats into your ability to accumulate money for retirement. Contrast this with a low-fee (and no surrender cost) option like Vanguard mutual funds where the expenses are generally about a third as high. Believe me your insurance agent or registered representative isn't going to show an option like Vanguard's or other similar low-cost, no-surrender fee providers.

Whether a variable annuity is the right financial product for you is one decision. However if this decision is yes don't succumb to the sales tactics and pressure of an advisor trying to sell you a high-cost product to enhance his or her commission. Shop for a low-cost, no-surrender-charge product with the features and benefits that are best for your situation.

Levered ETFs

A number of exchange-traded funds use derivatives and other devices to amplify the performance of the underlying index, such as the S&P 500. There are ETFs that seek to provide two or even three times the return of their index both long and short (inverse). Again, there is nothing inherently wrong with these ETFs as a product. When the market is moving in the right direction there is a lot of money to be made. But when the market turns against your position your losses will be magnified two or three times and can add up quickly. Also, levered ETFs do not track their underlying index well on a longer-term basis, as they are generally designed to follow only the daily changes. These can be great vehicles for professional traders and money managers, but in my opinion they are too risky for most individuals.

Self-Directed IRAs

This is not a financial product, but rather a type of account. Self-directed Individual Retirement Accounts are offered by a number of custodians and allow investment in a wider variety of alternative investment vehicles that are prohibited by more traditional custodians.

USA Today's John Waggoner has said of self-directed IRAs: "Just because you can do something doesn't mean that you should. You may be perfectly capable of cross-breeding trout with electric eels, for example, but you probably shouldn't do it unless you're very angry at fishermen. You can invest in a wide array of things via your individual retirement account, aside from the usual stocks, bonds and mutual funds. Office buildings? Sure. Small businesses? Check. Unregistered securities? Yep. And you can invest in all of these through self-directed IRAs. Should you? For most people, no. But for a few people, it can make sense."

Fraud is not uncommon here and the Securities and Exchange Commission has issued this investor alert about self-directed IRAs.

There are certainly legitimate providers and custodians of these accounts. For some investors this might be a legitimate option. For most investors, the addition of riskier or more complicated investing options can be a slippery slope at best. Real estate investments in your IRA? Do you not remember the recent financial crisis? Using your IRA to fund a business? If if fails, you'll lose both your business and your retirement account.

Don't be swayed by the hype of most of the folks peddling these accounts and the allure of the sometimes exotic investments that they can include.

Equity-Indexed Annuities

Equity-indexed annuities are an insurance-based product where the returns are tied to some portion of the performance of an underlying market index such as the S&P 500. Your returns are limited to a portion of what the index gains, and the risk of losses are mitigated by some sort of guaranteed minimum return. Such products were pitched heavily to baby boomers and retirees after the last market downturn, touted as an alternative to the risks of the stock market.

But there are two drawbacks for many such products: High expenses and surrender charges that keep your money locked in them for years. While most investors suffered major losses during 2008-09, my clients (and the clients of other financial advisors with whom I network) had generally made up those losses in a relatively short period of time and now find themselves significantly ahead of where they were. I'm not sure that an expense-laden equity-index annuity would have made them any better off.

If you purchase one be sure that you understand all of the details including index participation, expenses, surrender charges, and the health of the underlying insurance company.

Proprietary Mutual Funds

It is not uncommon for registered representatives and brokers, who are compensated all or in part by commissions or trailing fees, to suggest the mutual funds from a fund family run by their employer. While some of these funds are perfectly fine, all too often in my experience there are better options available. A lawsuit against Ameriprise Financial brought by a group of participants in the company's retirement plan alleges the company breached its fiduciary duty by offering a number of the firm's own funds in the plan. These funds then paid fees back to Ameriprise and some of its subsidiaries. JP Morgan settled a suit by some retail investors over the bank's registered representatives steering clients into their more expensive proprietary funds over those of other families.

While this is most common in the world of fee-based and commission-based advisors, if you are working with the advisory units of a fund company such as Fidelity or Vanguard you should also question recommendations that are exclusively or mainly into their own proprietary funds. Moreover anyone who pushes you to invest mainly with mutual funds offered by the same company who signs their paycheck should be questioned extensively as to why these funds are being recommended. Because their employer is pushing them to recommend these products or that the commissions are highest on these funds are not the answers you are seeking.

Load Mutual Funds

It is important that you understand mutual fund share classes. In the commissioned and fee-based world representatives often sell mutual funds that offer compensation to them and to their broker-dealers. "A" shares charge an up-front commission plus a trailing fee (often a 12b-1) of somewhere in the neighborhood of 0.25 percent or more. "B" shares charge no up-front commissions, but carry an additional back-end load as part of the ongoing expense ratio. This can amount to an additional 0.75 percent or more to the fund's annual expenses. In addition these shares also contain a surrender charge that typically starts at 5 percent if your sell the fund before the end of the surrender period. "B" shares have been largely phased out by many of the major fund providers. Lastly, "C" Shares typically have a permanent 1 percent level load added to the fund's expense ratio and carry a one year surrender period.

Nobody should expect to receive financial advice for free. However, understanding the costs and risks of the products and people who influence your money decisions can make a large difference in meeting your financial goals.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.

The above comments are general and reflect the author's opinions and should not be considered financial advice. No financial product is right or wrong in every case. Before making any financial or investment decision it is best to review your specific situation and consult a professional advisor.

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