A Tale of Two Brokers

A Tale of Two Brokers
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Brokers can be like sharks. They circle the waters looking for the weak and vulnerable. Then they pounce.

I receive many inquires from readers of my books asking my advice about recommendations they receive from their broker. Typically, these recommendations are in the best interest of the broker and his employer. They are rarely suitable for the investor. Here are two recent examples.

Broker #1: Deceptive advice about “risk free” investments

An investor had an FDIC insured Certificate of Deposit mature and wanted to invest the proceeds in something “equally safe and liquid.” He told his broker he might need access to the funds at any time within the next two years.

The broker recommended the Lord Abbett Short Duration Income Fund (LALDX). Not only did he assert that it was “like a CD”, but also that he “was paid by the fund”, so there was no charge.

The facts are quite different. Over 50% of the holdings of the fund are rated BBB (36.5%) or below (14.1%). These bonds face more solvency risk than higher rated bonds in the event of an economic decline. My reader’s CD is backed by the full faith and credit of the U.S. Government. There’s no credit parity between these two investments.

The Lord Abbett fund has a high expense ratio of 0.60%. It also has a front end sales charge of 2.25%, of which 2.00% is designated as a “dealer’s concession.”

My advice

I advised him to consider Vanguard’s Prime Money Market Fund (VMMXX) instead. It’s one of the most conservative investment options offered by Vanguard. It has an expense ratio of only 0.16%. There’s no sales charge. According to Investopedia, “This fund is suitable for conservative investors whose tolerance for risk is low or who may need quick access to the funds on a daily basis.” That’s the precise requirement of this reader.

An objective broker — one not motivated by fees — would have recommended the Vanguard fund and not the Lord Abbett fund.

Broker #2: Deceptive advice about bonds

Investors are seeking higher yields from bonds, motivated by historically low current yields. These investors often don’t understand the evidence indicating they would be better off taking no risk with the bond portion of their portfolio. Instead, they could increase expected returns by allocating more of their portfolio to stocks, and viewing their bond portfolio as a ballast that serves to mitigate market volatility.

Many also don’t understand that higher yields than the risk free rate of return (which is generally considered to be the interest rate on a three-month U.S. Treasury bill) typically means accepting a higher level of risk.

Broker #2 recommended J.P. Morgan’s Efficiente Plus DS 5 Index (Net ER) as a replacement for a low risk bond index fund. This is a complex product that seeks to generate returns from investing in ETFs and a cash index “to provide exposure to a universe of diverse assets based on the efficient frontier portfolio analysis approach.”

A look at the disclosed conflicts of interest should scare away most investors. Here are some of the most glaring ones:

The CD’s don’t pay interest.

Investors don’t receive dividends or other distributions on the underlying securities.

J.P. Morgan’s economic interests “are potentially adverse to your interests as an investor in the CDs.”

A fee of 0.85% per annum will be deducted daily!

My personal favorite is this one:


My advice

I suggested the investor consider iShares Barclays Short Treasury Bond ETV (SHV). This fund has an expense ratio of only 0.13%. It seeks to track the investment results of the U.S. Treasury Short Bond Index. It invests 95% of its assets in U.S. government bonds.

Another option would be Vanguard’s Bond Market Index Fund (VBMFX). It’s expense ratio is only 0.15%. It’s designed to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index, which is a broad, market-weighted bond index. It holds a mix of U.S. Treasury Notes and investment-grade, taxable, corporate and international dollar denominated bonds, mortgage-backed and asset securities. This fund is often used as the core bond holding of investors.

Either fund would serve as a low risk portion of a portfolio, designed to mitigate stock market volatility.

The J.P. Morgan fund would not be suitable for this purpose.

A pattern

As in these two cases, brokers tend to recommend expensive, actively managed funds. They also frequently prefer complex investments, and don’t fully explain the risks.

All of this begs the central question: Why would you rely on anyone for investment advice who won’t confirm in writing they will always put your interest above theirs?

If you would like to share an investing experience with Dan, send him an e-mail at: dansolin@yahoo.com. If he uses it in a blog, he will send you an autographed copy of The Smartest Sales Book You’ll Ever Read.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

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