Watch Those Fees

I'm a CPA and worked for several years at Ernst and Young, a big 4 accounting firm. When I was working there, I spent many days and weeks working on prospectuses, which are the shareholder reports that are the ultimate end result of an audit. Even though I was helping to produce these important documents, it wasn't until I had several years of experience with them that I finally began to get comfortable with understanding how to read and interpret them.

This is a disturbing fact of our financial systems: very few investors will ever have the opportunities I did to get up close and personal with audited financial statements. If that is the case, then how can they be expected to make informed decisions about how and where to invest their hard-earned money? The answer is: They can't! Which is exactly how many investment firms, insurance companies, and big banks would like it to remain. After all, an uninformed investor is usually a happy investor.

The sad part of this is that many investors do not want to learn more about investing. Their eyes get glossy when the subject turns to asset allocations, and they reply "I have a financial planner to make those decisions." Well, what they don't know is that he is probably just an insurance salesman, and may know less about investing than them! The bright side of this is that financial adviser gives the uneducated investor someone to blame when things go sour.

I'll give you an example. A close friend of mine, Sara, got a job as a school teacher right out of college. Soon after she started working, Sara met with a representative from NEA Valuebuilder, one of the companies that had a retirement plan for employees of Sara's school. NEA offered a 403b plan that was packaged as a variable annuity. Sara didn't know what a 403b was or who variable annuity was, but the representative was a close friend of Sara's parents, and everyone knew that Sara was making a wise choice to start saving for retirement when she was still so young.

Sara didn't asked the rep too many questions, if any at all. She wouldn't have known what to ask anyway - she had majored in fine arts, not finance - and would leave those decisions to the experts. Sara worked as a school teacher for seven years, dutifully contributing the same amount each pay check, for a total contribution over all seven years of $20,000.

We were friends for this entire period, but she never once asked me for any advice or information, so I never offered any, even though I had private concerns about how she had invested her life savings. Two years after leaving her teaching job to work full time as an artist, she could no longer contribute to the fund, and asked me to help her make a decision about what to do with the money in her 403b.

After calling NEA Valuebuilder and requesting a prospectus, I confirmed my fears. Only, it was worse than I could have imagined. Allow me to explain. In every prospectus of every mutual fund that sells shares in the United States, there is a table detailing the approximate cost of investing $10,000 in the fund over a ten year period. I turned immediately to this page when I got the prospectus, and the approximate cost was $5,600. (NEA Value Builder Prospectus) I was shocked. In all of my experience I had never seen fees this high. I immediately showed the fee table to Sara and explained what it was. I then showed her the fee tables of the index funds I suggested she consider. They each had approximate 10 year cost of under $300. (Spartan Index Funds)

The reasons for the extremely high fees are because it is an annuity, which is an insurance product. Sara's retirement savings were insured for many things at a great cost. This type of variable annuity is an antiquated investment vehicle that really no longer has a place in the great majority of portfolios, and absolutely not in the portfolio of a very young school teacher just starting out on the road to financial freedom. She didn't need this type of insurance; she needed appropriate risk and the opportunity for compounded returns.

The very sad part is that all of this information was available to Sara when she set up the plan. It could be said that the "Financial Advisor" who set up Sara's plan should have explained this information to her, but he was really just an insurance salesman, so he may not have even understood the plan, much less the prospectus.

Sara decided to cut her losses and roll her money into an IRA with low cost mutual funds. Even though her NEA Valuebuilder plan was a 403b and therefore she was allowed to roll the money into an IRA, she still had to pay NEA Valuebuilder over $1,000 to cancel her annuity contract. Over time the great advantage of the lower fees will boast her returns and more than make up for the loss. When she finally did do the rollover, the total in her account was just over $29,000. After nine years, she had only earned $9,000 in her annuity, despite never taking any disbursements. The high fees had destroyed her ability to benefit from compounded returns. That is the high cost of ignorance.