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High Net Worth Investors, Transparency and Sensible Risk Management
In the past two months, I’ve worked with two high net worth families — both with investable assets in excess of $40 million — who now better understand the ugly side of the financial services industry.
 
Bond Markups
The first family sold their business for more money than they ever imagined they would have or could spend. The family took the prudent step of allocating almost all the money to high-quality municipal bonds. Unfortunately for them, the broker who built the portfolio effectively charged them more than $600,000 for the relatively simple task of building out a bond portfolio (and significantly more on trades occurring after the portfolio was built).
 
For those of you who aren’t familiar with the bond market, you’re probably asking how this could happen. It’s because bond markups don’t have to be disclosed. A bond markup is the difference between how much a broker paid for a bond and how much he or she sold it for. In this case, the markups averaged about 1.2 percent, meaning the broker-dealer was essentially buying bonds for $100 and selling them for $101.20. On a portfolio of this size, these are particularly egregious markups.

Too Much Risk
The second family also sold their business, which generated taxes of several million dollars. Instead of paying the taxes out of the proceeds of the sale, they margined their account to pay the taxes. (It isn’t clear whether the person they were working with convinced them to do this.)
 
Then, virtually all of the client’s assets were invested in an undiversified individual stock portfolio and a hedge fund. Keep in mind that this would be an insane level of risk even without the leverage created by margining the account.
 
These are just two examples I’ve seen showing me that many high net worth investors are treated as badly as smaller investors. To make this diatribe of some practical use, here are prudent steps you can take when selecting a financial professional to work with:
  1. Make sure you understand the direct and indirect forms of compensation the firm receives from managing your portfolio. Examples include investment advisory fees, kickback payments from fund companies in the form of sales loads and12b-1 fees, and bond markups.
  2. Strongly consider working with financial professionals who don’t receive any compensation based on trades that you place or from third-party sources like fund companies or broker-dealers. Payments from third parties are a natural conflict of interest and increase the likelihood that you won’t receive advice that is in your best interests.
  3. Ask how they invest personal money. Do they use the same funds and types of securities they’re recommending to you? If not, you probably shouldn’t work with them.

Of course there are certainly other factors you'll want to consider, but these three are crucial. If red flags are raised on any of these three, you likely need to keep searching.

Copyright © 2011, Buckingham Family of Financial Services. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

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