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Help Clients Understand Investments

Knowledge about investments is not intuitive and it is not uncommon or surprising that our clients have plenty of misconceptions and confusion regarding their own IRAs.

When helping a client understand their accounts, or make initial choices to fund their IRAs, it is important to keep this in mind and share this with clients. Often, I have found clients are embarrassed that they don’t know where their money has gone for the past several years, and cannot even tell the difference between an IRA, a stock, and a mutual fund. It is helpful to begin with a bit of reassurance that this confusion is not a matter of intelligence, just knowledge, and with a little education they will be able to make informed choices regarding their investments.  

This emphasis on education is key as you approach the process with your client. As financial counselors, not advisors, we give our clients all the information they need to make the best choice for themselves. Our success is not measured by the choices our clients make or their monetary gains, but by whether or not they are empowered to make deliberate choices and know why they choose what they choose. Can your client tell you what his investments cost and what the target of his funds are? This is success, even if you would advise a different investment.

Analyzing Your Client’s IRA Statement

Suppose a client brings  his/her IRA year-end statement to you and wants you to help her understand her investments. Keep in mind the goal is to educate, not advise. I suggest the following methods to review the accounts together. The best place to start is with some basic terminology followed by the funds themselves, then fee structures, brokerage houses, etc.  This is my typical pattern:

1. Terminology—Often, I hear clients say things like, “a Roth is really conservative” or “mutual funds are risky,” which reveals their confusion on the distinction between investment vehicles and the investments inside them. I suggest taking five minutes to explain that an Individual Retirement Account (IRA) is the “basket” in which investments are held. Look at your client’s portfolio and explain the basics of traditional versus Roth IRAs to make sure she knows which type she has. Most IRAs brought to me as a financial counselor to analyze consist of either actively managed or indexed mutual funds. Of course, IRAs can contain many other things, including ETFs, individual stocks and bonds, etc. However, most clients who need assistance deciphering their accounts are not in these types of investments, so for the purposes of this article, I address only mutual funds. Take a moment to make sure the client understands how a mutual fund works, including benchmarks, indices, and index funds.

2. Analyze Funds—To examine the actual funds in your client’s account, look at the name of each fund and plug the ticker into a financial website such as Google Finance or Yahoo Finance. Have your client read the description, objectives, and holdings of the funds with you. Look at the performance over several time periods. Enter the ticker for the client’s fund and the benchmark simultaneously over several time periods to determine how the fund is performing. Figure A shows a fund a recent client owned in blue with its benchmark, the Russell 1000 Growth index, in red over the most recent ten-year period. You may have to do a search for the prospectus to find the fund’s benchmark; other times it will be clearly stated in the description of the fund.

Figure A

Ask your client about his or her time horizon and comfort with risk to help determine if funds align with goals. Ask about any other retirement accounts, such as a 401(k) or Thrift Savings Plans. Each account does not need to be balanced as long as the overall portfolio is balanced. For example, an IRA may contain only an aggressive stock fund, but a 401(k) may be mostly in large cap stock and bond funds to balance the entire retirement portfolio. Or perhaps what appears to be a well-balanced portfolio is revealed to be much too heavily weighted in one sector or investment type once looking at the portfolio in aggregate. Maybe this is the only account and it is wholly invested in one conservative bond fund. This is where your job as an educator is key. Simply pointing out if there is no exposure to stocks and that the client does not expect to retire for another thirty years can lead to the conclusion that diversity is needed. It is your client’s job to make the determination as to whether investments are appropriate, but you can help your client understand the basic distinctions and ask questions that cause the client to examine his/her portfolio.

3. Explaining Fees—Determine what type of mutual fund your client owns. It may be an indexed mutual fund, meaning it tracks a market index, such as the S&P 500.  This index fund will typically have low fees (less than 1%, hopefully much lower) as the stocks or bonds in the fund are predetermined by the index and no fund manager is being paid to make market projections. Alternatively, if it is a managed fund, the fund has one or several fund manager(s) attempting to beat overall market returns, or a specific benchmark. Managers charge commissions or higher expense ratios, or both, for their services. Compare the managed fund to an index fund tracking the same benchmark, then subtract the difference in fees each fund charges to see the true winner over the given time period. Your client may need to call their advisor to ask about fees and how he or she is paid. Some statements reflect the fund’s fees, but not the advisors’ commissions.

 

Explain to your client what loads are if she or he has class A (front-end load), B (back-end load, higher fees), or C shares (small back-end load, higher expenses). Further, explain what a fiduciary is, and whether the advisor is one. Retirement advisors must be fiduciaries.

Many financial counselors automatically denounce funds with high fees and it may be difficult to resist telling your client to ditch these funds in favor of lower cost index funds. Remember that as a financial counselor, education is your goal. Your client has to determine if the higher fees and commissions are worth it to her to continue paying, once you break down the true cost of her investments.

4. How to Avoid Advice—The question to pose to your client, after explaining the terminology, examining her funds and fees and looking at the basic math together, is whether she believes she has invested well. You may assist the client through the process of changing investments if he/she chooses, but you cannot tell the client which is the best option. That may be the hardest part of your job some days.

This  may be a good time to relay to your client a recent report by Standard and Poor’s, which reports that over the last 15-year period, over 92% of fund managers underperformed their benchmarks. Ask your client if he/she is confident that the manager is one of the 8% beating the index fund and the implication is obvious. Sometimes 2–3 percentage points do not seem all that much to clients, so plug the numbers into calculators such as those on FINRA.org or use your financial calculator to do the math and show clients what fees actually cost them.  

Remember that your personal performance as a financial counselor should be evaluated on whether your client leaves your session well-informed and empowered to make the best choice for his or her situation, not on the choices your client eventually makes.


Michelle Pimentel is a recipient of the FINRA Military Spouse Fellowship and has been an AFC® since 2010. She has worked in the personal finance field since 2007 and is a candidate for CFP® certification having passed the CFP® exam. She is currently a Personal Financial Counselor with Zeiders Enterprises, Inc., serving members of the Air Force in Okinawa, Japan.

The Standard

3rd Quarter 2017


Thank you to this issue's contributors:

LaShawn Brown

Carrie L. Johnson

Carol Kando-Pineda

Elizabeth Martinéz

Jinnifer P. Ortquist

Michelle Pimentel

Brenda Vaughn

Lisa Ware

Robert Weber 

Rebecca Wiggins

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