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<i>The Ethical Investor</i>: Wall Street Ripoff #10 - Recommending Products With Enormous Sales Commissions

If a financial product is too complicated and too complex for you to understand, this is not an accident. It is intentional. And it will cost you.
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We have already seen in this series that many investment products on Wall Street like many mutual funds have large annual costs associated with them making them a poor investment choice in the long term. If a mutual fund total costs run 2% per year and the fund generates a 3 percent real return after inflation you are, in effect, giving Wall Street two thirds of the profits that are earned on your investment portfolio. Even ETF's that cost a half a percent to 1 percent per year can end up costing you as much as one third of your total profits over time.

You would think Wall Street would be comfortable taking a third to two thirds of your profits. But remember, this is Wall Street. Greed is what they do. There are other more complex products out there that cost investors even more. Not only can the annual costs exceed 2 percent per year, many of these products have enormous sales commissions attached to them of 5 to 12 percent. Brokers push these complex products because of the large sales commissions they earn, but the bank or insurance company also loves it because they aren't paying the commission, you are. And think about it, if the company is paying its salespeople a 5 percent upfront commission, they must be making multiples of that over the life of the product or they wouldn't do it.

As a general rule the more complex and complicated a financial product is, the higher its cost to investors and, most likely, the higher sales commissions it earns for your broker. The entire idea is to create financial products that are so complex that no one completely understands them, it is impossible to analyze them and so it is easy to hide large expenses and fees inside them.

When it comes to complexity of products, the insurance industry has excelled. And, most insurance products, especially those that pretend to be investment products, have very high costs associated with them.

The first rule about insurance is that it is so costly that if you can afford to take the loss don't buy the insurance. You should only buy insurance for events that are so unpredictable and destabilizing to your family that they really could not get by without it.

I bought an alarm clock at RadioShack recently and the salesperson asked me if I wanted to buy the three year extended warranty on the alarm clock. The alarm clock costs $15 and the extended warranty was offered for an additional $12 for three years. The extended warranty is really just an insurance contract and because I figured I could survive if my alarm clock failed in the future I figured I could get by without their extended warranty.

Possibly the highest cost product the insurance industry offers is the variable annuity. It pretends to be a combination of an investment product with an insurance guarantee that ends up costing much more than simply buying insurance and investing your money broadly in the stock market. Sales commissions to brokers who convince their clients to buy variable annuities exceed 5 percent. And the annual costs are greater than even a mutual fund as you end up paying two middlemen, both the insurance company and the fund administrator.

But even more traditional insurance products like life insurance are very costly. Insurance companies get away with it because proper pricing depends on understanding annuity tables and probability calculations unavailable to consumers. It is why some of the largest buildings in most American cities are owned by insurance companies. If you have to buy life insurance stay away from whole life policies also known as cash value, universal life or variable life policies. Buy term insurance and only for the shortest time period you absolutely need it.

Another general rule, if you are hearing about an investment opportunity through a television infomercial it is probably fairly high cost to you. Somebody's paying for the ad time and for those actors who endorse the product.

A great example is reverse mortgages. Even with 30 years of investment experience, I wouldn't have the first clue as to how to analyze the true costs of a reverse mortgage. They are enormously complex and combine all the worst attributes of mortgage products, insurance and annuities. In addition, many reverse mortgage companies have come under scrutiny recently by regulators who find their sales practices and operations fraudulent and deceptive.

Many of these high cost products exist and investors are attracted to them because they promise a "guaranteed" return. There really is no such thing. First of all, when times get tough, the very institutions that are making such guarantees themselves will face insolvency and will not be around to act on that guarantee. Second, there is little value in guaranteeing a 4 percent annual yield in dollars if inflation returns to say 10% per year. Yes, you get your 4 percent per year, but you will be losing 6 percent per year in purchasing power.

Just remember, if a financial product is too complicated and too complex for you to understand, this is not an accident. It is intentional. And it will cost you.

20 Ways Wall Street is Ripping Off Small Investors:

  1. Providing nominal returns, not real returns.
  2. Encouraging too much diversification, if that's possible.
  3. Hiding fees and expenses.
  4. Turning you into a passive investor.
  5. Convincing you that money markets are the same as cash.
  6. Telling you that bonds are safer than equities.
  7. Explaining that in the long run equities outperform bonds.
  8. Simply by lying about their products.
  9. Convincing you that their bank is a large, stable, safe operation to deal with.
  10. Recommending products that have enormous sales commissions attached to them.
  11. Cheating you on bid/ask spreads.
  12. Selling you what they don't want.
  13. Measuring your success in dollars.
  14. Lending your securities to others.
  15. Ripping your eyes out if you ever try to close your account.
  16. Grabbing any slight positive real return for themselves.
  17. Sticking toxic waste to small investors.
  18. Pretending they can pick stocks.
  19. Acting like they are your best friend and they have your best interests at heart.
  20. Knowing next to nothing about the value of holding real assets like gold and real estate.

John R. Talbott is a bestselling author and financial consultant to families whose books predicted the housing crash, the banking crisis and the global economic collapse. You can read more about his books, the accuracy of his predictions and his financial consulting activities at

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