American Funds. Merrill Lynch. Fidelity. These are all mutual funds names you may have heard of. Especially, if you use a broker or fund advisor to help you invest.

Every financial institution has its own specific product mix of such funds that its investment advisors funnel into client accounts. These financial products are sometimes mutual funds owned by the firm. Other times, they’re funds with which the firm has a marketing relationship. Each has its own specific sales pitch and fee schedule. These products are almost always actively managed, and many are startlingly expensive.

The average mutual fund expense ratio is 1.16%, according to research by Vanguard and Lipper. For active funds, that average is even higher. And, want to know why you paid 5.75% up front to buy an “A” share branded fund? It’s because you also paid a front or back-end load fee –  charged by your advisor for the right to buy or sell your funds. 

Why Pay More?

Maybe there are plausible reasons a firm might favor their own brand of products over everything else. Perhaps these funds are simply better performers than the competition. After all, you can make up fees with performance, right? 

A more likely explanation for any recent outperformance is luck and large numbers. A major fund company can own 30 or 40 different mutual funds, and many of them have overlapping mandates. At any given time when one fund is lagging, it’s a good bet that some other fund in the stable is having a wonderful 3-year run. That fund can be marketed to clients as suitable while the lagging fund is set aside to rebuild. If it recovers, it will be sold in the future. If it cannot, its assets (your retirement funds!) are simply rolled into a better performing fund. This is not a rare occurrence.

A study by Dimensional Advisors found that the five- and 10-year survival rates for equity mutual funds were 71% and 57% respectively. Sometimes the losing manager leaves the company, but more often he moves to a different team and a new product is born.

A broker dealer is considered a financial intermediary by FINRA (Financial Industry Regulatory Authority), and is held to a standard requiring them only to make suitable recommendations to clients. And that is about it.

There is no fiduciary duty of loyalty or care, and no need to place a client’s interests above those of the firm. This loose standard of suitability allows a broker to recommend their own brand of S&P-based fund, complete with higher fees, over a practically identical low-fee fund holding the same exact stocks! And many brokers take advantage of it. The only thing that matters to the regulators is that the asset mix in the underlying fund is suitable for the client, and that the fees aren’t excessive (what’s “excessive” anyway?)

Note: Registered Investment Advisors have a fiduciary duty towards its clients, and must act in a client’s best interest always. They do not sell financial products. Coincidence? Unlikely.

You Deserve More Transparency, Not A 'Designer Mutual Fund'

You might happily pay more for a designer clothing brand, to show off your sense of quality and style. But a designer mutual fund? When is the last time you showed off your shiny new Merrill Lynch mutual fund portfolio with all the A shares to your friends? Or bragged about the annuity you were just locked into, paying 3% up front and 2.5%+ per year for the foreseeable future?

You probably never have. But do you know who is justifiably proud of a portfolio like that? Your broker. Next time you’re thinking about getting financial advice, consider working with a Registered Investment Advisor.