Do you have a profit sharing or similar retirement account that your employer or partnership is contributing to on your behalf? Many physicians do, and they think they do not have any control over how the money is invested or who makes the decisions. These assumptions, which are often wrong, can be very expensive over time.
Here's a typical situation you may recognize. I am currently working with a physician (let us call him Dr. Smith) who joined a practice as a partner a few years back. As part of his contract, the partnership makes an annual contribution of about $40,000 to his profit sharing account. Dr. Smith works long hours and has other family responsibilities just as many of you do, and he assumed that someone is taking care of investing the money.
Behind the Curtain
After some digging, we found that the accountant who had set up the retirement plan for the partnership is investing the money. It seems he was chosen not based on his investment expertise, but because he knows someone who knows someoneâ€”not an uncommon situation. And even though some of the partners have been unhappy with the performance of their portfolios, no one has done anything about it.
What disturbed me most is that Mr. Smith's profit sharing portfolio now entirely consists of A or B shares of funds of just one particular company that the accountant has bought without consulting him. This fund company came out of the bubble era with a tarnished reputation. One could achieve the same performance at probably 1/20th the cost by buying the Nasdaq 100 index.
Following Money Trail
Why did he buy these funds? Because these are A or B funds, which means the accountant gets large commissions from selling them to clients. A funds are funds with front-end loads or sales charges, generally up to 5%. In addition, the A funds in Dr. Smith's portfolios have expense ratios above 1.5% (compared to about 0.25% for good index funds, 0.1% plus small brokerage fees for exchange traded funds, and less than 1% for excellent actively managed no load funds).
B funds are even worse. With these funds, Dr. Smith is now stuck with a situation where if he continues to hold the funds, he will be paying expense ratios of around 2% per year, and if he sells them, he will pay a redemption fee that starts at 5% in the first year and gradually declines to zero in 6 years. Further, the performances of the funds have been mediocre to poor, and there is no reason to believe they will improve dramatically in the future.
Hard Lessons Learned
No matter how you look at it, the accountant, whom Dr. Smith never chose or authorized to make investment decisions, has cost Dr. Smith a lot of money, a big chunk of which will end up in the accountant's own pocket.
Some of you probably have been in this not-too-uncommon situation already. If not, consider yourself lucky and take the following lessons to heart:
1. Before letting anyone make investment decisions for you, make sure you understand their investment philosophy and method, and have confidence in their knowledge and integrity.
2. Take the time to fully understand your retirement plans and take charge of them. If the plan does not give you the right flexibilities and options or has high built-in costs, start talking to your partners or employer about making changes. It may take some time to convince them, but ultimately everyone will benefit financially.
3. Never buy any fund that offers alphabet shares (ie, A, B, etc). Their fees are almost always too high, and there is overwhelming evidence to show that you will be much better off investing in low cost no-load funds.
4. Recognize that you cannot get good investment advice for free. You will always pay for it, either as hidden fees or as explicit fees to a fees-only advisor. Most physicians will be better off delegating investment management to a reliable professional. But make your selection deliberately, not by default.
Chandan Sengupta, author of The Only Proven Road to Investment Success (John Wiley; 2001)
and Financial Modeling Using Excel and VBA (John Wiley; 2004), currently teaches finance at
the Fordham University Graduate School of Business and consults with individuals on financial
planning and investment management. He welcomes questions or comments at firstname.lastname@example.org.