Read The 9 Steps to Financial Freedom Online
Authors: Suze Orman
Front-end loaded funds charge a load up front. They are also identified as A share mutual funds. When you see the name of the fund spelled out anywhere, if it has an “A” or says “A shares” after the name, then you know it’s a front-end loaded fund. If you invested $10,000 in a 5 percent loaded fund, and decided two seconds later to withdraw your money, you would get back only
$9,500—the adviser got that $500. This fund would have to go up more than 5 percent in value just for you to break even.
Funds with a back-end load, also known as a deferred sales charge, are even worse.
When mutual funds first came onto the scene, you could buy one only through a broker, so they were all loaded funds. Over the years, though, many mutual fund companies came out with no-load funds, and slowly but surely investors began seeing their value and investing. This migration was putting a big dent into the profits of brokerage firms that sell only loaded funds, so they came up with a way to make you think you could buy a no-load fund through them: It’s called a back-end load fund and it has a big charge, known as a 12b-1 fee, hidden in the expense ratio. Any fund with a “B” after its name levies this fee. Let me explain how this works.
These funds are typically sold to you by a financial adviser. Some of these advisers sell you these funds under the pretense that you are not going to pay a load to be in the fund as long as you stay in it for five to seven years. If you cash out before then, there will be, the adviser will explain, a “surrender charge” starting at around 5 percent and going down by 1 percent each year until it reaches 0 percent. (In a true no-load fund you can cash out the same day without paying a penny.) Not too bad, you might think, since I plan to leave the money in there for a long time anyway, so it won’t really cost anything. Wrong. You will be stuck paying a much higher expense ratio because of that 12b-1 fee I mentioned earlier. It can add 1 percent to your overall expense ratio every year. You need to understand how that extra one percent can add up over the years. If you stay in the fund for fifteen years, and it charged you a 1 percent annual 12b-1 fee, the cost of that 12b-1 fee is like paying an extra 15 percent sales commission. Who can afford that?
This 12b-1 fee is in addition to the other fees as well. You’ll
also have to pay the management fees and other costs that are part of the regular expense ratio. The 12b-1 fees are put in place to pay the adviser’s fee for having sold you the fund. How it works is that you buy the fund, the brokerage firm advances the broker’s commission to him the day you buy it, and you keep paying and paying so that the firm will get back the money they paid to the broker. Your 12b-1 fee is how they get the money back. If you close the account early, your surrender charge is what guarantees the company it will get back more than it paid the broker: a no-lose proposition for the brokerage firm, but you lose all around.
In other words, these B-share funds with large 12b-1 fees are a rip-off. I would avoid them if I were you. And even though some fund companies now offer a deal where your B-share fund automatically converts to A shares (they tend to have a lower expense ratio) once your “surrender” period is over, I still think those first few years of paying such a stiff 12b-1 fee is too costly. You really should focus on true no-load mutual funds.
Why Would My Adviser Sell Me These Funds?
Because that’s how he or she makes a living, and you’ve not chosen an adviser wisely. True financial advice is to tell the client how to get the most bang for the buck, even if it means the adviser won’t make a lot of money with the transaction. Advisers are there to help you get rich, not to get rich off you. It’s the adviser’s fiduciary responsibility to tell you if there’s a less expensive way for you to make money—and give you the choice of what you want to do after explaining how much each of your options will really cost you.
But no-load funds can be purchased without the help of an adviser—no middleperson, no commissions, no hidden costs, just smooth sailing to greater and greater wealth over time. And as I mentioned, many advisers in fact use no-load funds and
ETFs for their clients, choosing instead to charge a flat fee for their services. Such fee-only advisers are the only advisers you should ever consider. Do you need an adviser? If after reading this next section you feel you do, then you do, for your own peace of mind. But you may just want to test the waters yourself. At my website,
suzeorman.com
, you can learn about
The Money Navigator
. This is a monthly newsletter that I launched in 2011 along with economist Mark Grimaldi.
The Money Navigator
highlights no-load mutual funds and ETFs that Mark recommends for investors saving for retirement. The newsletter also provides recommendations for mutual funds that are popular investment choices in many 401(k)s. You can sign up for a free one-year subscription at
suzeorman.com
by entering the code “financial freedom.”
TESTING THE WATERS
Whether you want to believe it or not, you and you alone have the best judgment when it comes to your money. Here’s a story about me and my mom:
A few years ago, I had a terrific hunch about a particular stock. I just knew it was a great buy, especially priced as it was at around $1.50 a share. So I told the person that I love most in the world, my mom. My mom has always lived really, really frugally and, since my dad died, has managed to have enough to live comfortably on, but she has never been a great risk taker in the stock market; in fact, she still worries about me when I buy or sell stocks. This time, to my amazement—maybe she caught the excitement in my voice—she said she also wanted to
invest in the stock I had chosen—$5,000. Eighty-three years old, and now she decides she wants to jump into the market!
Now—again to my amazement—I began to caution her. Did she understand that any stock that was selling for only $1.50 a share was totally speculative? Yes, yes, she understood that perfectly well. Did she understand that she could lose the entire $5,000? Yes, she understood. She felt the worst-case scenario was that if she lost it all, she would have $5,000 less to leave me when she died. Was I willing to take that risk? (I hate it when she outsmarts me at my own games.) I was willing, so my mom and I invested in the stock that same day, each of us putting in $5,000.
Everything was holding steady pretty much until a few months later, when the stock started to go down and down and down. My mom, who by now was really into this, began calling me up every day and saying, “What do you think we should do?” I would say the same thing I would have said to my clients, “What do
you
think you should do?” and, satisfied, she’d say, “Let’s just hold it.” That was how I felt, too, until the day the stock hit twelve cents a share, which made me begin to doubt my own inner voice. Five thousand dollars is a lot of money, and this was my very own mother.
That was the day she called up to say, “Let’s buy more.” I couldn’t believe it.
I said, “What did you say?” and she said, “I just have this instinct to buy more.”
When she said this, I’m sorry to say I did not encourage her to follow her instincts. Instead I said something to the effect of, “Mom, are you crazy? This stock is almost belly-up and we can’t throw good money after bad.” I’m also sorry to say that now she began to mistrust her own instincts as well and simply agreed with me. We left our money where it was, but our hopes fell and now we both trusted less in what we had believed about the stock.
To make a long story short, the stock fluctuated between twelve and twenty-five cents a share for almost a year, then: boom. It started to skyrocket, and soon after that we had both tripled our money. One day, while the stock was still at this high, my mom called again. “Suze,” she said, “I’ve decided that it’s time to sell.” This time I didn’t stop her from listening to her inner voice. I said, “Go for it.” She made three times the money she put in, and she was perfectly happy about it.
Even so, my mom would have made ten times, not three times, her money if I hadn’t drowned out her inner voice and made her doubt what she knew to be true for her. If that spark of instinct had been guiding her actions, she would have been far better off than she was by letting my doubts get in her way.
The moral of the story is that—whether you want to believe it or not—you and you alone have the best judgment when it comes to your money. You must do what makes you feel safe, sound, comfortable. You must trust yourself more than you trust others, and your inner voice will tell you when it is time to take action.
I’m not in any way suggesting that if you take your nest egg and go out and find a speculative stock to invest it all in, you’ll get rich. You won’t. You’ll be a sitting duck if you do that. What is more, I doubt your inner voice would guide you in that direction anyway.
Nor am I suggesting that you shouldn’t listen to others or learn about what you’re planning to invest in. You need information to make good decisions. But your inner voice will help you weigh that information properly. What I am suggesting is that you test the waters before you jump in with everything you have and that you practice listening to that inner voice. As soon as you see how easy it is to stay afloat, and get used to the investing temperature, so to speak, you very well might want to go in deeper.
It doesn’t matter if you have a large lump sum you want to invest or if you’re just starting from scratch and want to put in a little here, a little there, as you can. Rule number one is that to invest in the stock market (through mutual funds, exchange traded funds, and the like, not just by buying and selling this stock or that one, the way my mom and I did), you must invest only money that you will not need to touch for at least ten years. Why? Because, as we’ve seen, there has never been in the history of the stock market a ten-year period of time where stocks have not out-performed every other investment you could have made.
Not that history always repeats itself, but this is a spectacular indicator. However, if you do not give your money ten years, you will be taking a significant risk. If you don’t have the time to leave this money sitting there, it is possible that when you do need to take it out, that need will arise at the worst possible time. Let’s say you invested in 1999 and were planning to withdraw the money to buy a house within the next four years. You decided, Okay, I’ll just invest in the market, make all I can, and then have more money when the time comes to make the down payment. One year later you find the house you want and make the offer, which is accepted—on April 14, 2000, a day the market goes down considerably, and the day you had decided to sell, for you need your money. You will most likely take out far less than you initially put in. If you could have just waited—but you could not, for you needed the money to buy your home. So time is everything.
Remember dollar cost averaging (
this page
)? This is the technique that works so well for long-term growth, in which you are investing wisely by limiting your risk. If you are investing that $50 or more a month, or if you have a huge stash of cash in a savings account that you now feel right about testing the waters with, this is your method of investing, because with
dollar cost averaging you raise your chances enormously of ending up a winner.
I am not talking here about you turning into one of those tycoons in B-movies who is always shouting, “Buy, buy, buy,” or, “Sell, sell, sell,” into the half dozen phones on his desk. Instead I’m talking about you venturing into the market in a safe way, spreading your money among dozens or hundreds of stocks, via mutual funds that gifted professionals spend their lifetimes watching and guarding, and having time and the market touch your money with magic. These days the richest and savviest investors may like to shout, “Buy, buy, buy,” or, “Sell, sell, sell,” into a phone from time to time for the thrill (and potential payoff) of playing the market on a hunch or a tip. But these same investors have most of their money exactly where I am going to tell you to put yours: in a safe place, where over time it will grow and grow.
If you are reading this and still feeling your inner voice say,
No, I can’t do this, it’s not right for me
, then listen to that voice and read on, because I will also tell you how to choose an adviser for your money, if that’s what makes you feel best.
But if you can, try testing the waters on your own first. Most people, I find, discover they truly love dealing with their money once they understand how to do it. Just remember: Give your money ten years to grow.
Let’s say you have $20,000 to invest. Maybe it’s sitting right now in a retirement account at work, and you think you might want to be more aggressive with the way in which you invest it—or some of it. Maybe you’ve just gotten an inheritance or a huge raise at a new job. Maybe you’ve just had this money sitting in a savings account, have felt for a long time that you could do more with it
than leave it in that savings account, and suddenly decide: Now’s the time. Whatever the case, let’s say it’s $20,000, but it can in reality be more or even much less. Let’s see how to invest it.
So that you can get used to the investment waters, rather than investing 100 percent of it all at once, I want you to divide it up and start investing slowly over the first year, to see how it makes you feel. The chances, I think, are good that by the end of the first year you’ll be ready to plunge in.
Take 80 percent of what you have to invest, which in our example is $16,000, and put that money in a Treasury bill or note, or just leave it in your money market or savings account, anywhere it will be kept safe for you for about a year. After that year is up, it will be up to you if you want to keep investing it so safely, invest more on your own, or if you want some professional help in investing it. Your inner voice will tell you which is best for you. Trust yourself.