Advisor Today > > August 2001: Managing Money

Managing Money: Recommending the "Right" Funds

Your first step is to determine your client's risk tolerance, goals and suitability.

Janet C. Arrowood

Recommending the "right" mutual funds to your clients can be a challenge. First, you have to determine the client's risk tolerance, needs, goals and suitability and develop some sort of asset allocation. Then you have to choose one or more families of mutual funds, always being aware of break points, reduced sales charges, rights of accumulation and so forth. Then you have to decide what type of shares to recommend. The SEC has a website that features a "share calculator" and I highly recommend you visit this site: www.sec.gov/investor/tools/mfcc/mfcc-int.htm.

Some fund-share classes are available only to investors moving money from a retirement plan to an IRA within the same fund family and some are available only to those with $1 million or more to invest. Some are no-load and some are low-load. If you are registered with a broker-dealer, you are usually not allowed to even mention the no-load funds. Not all broker-dealers have arrangements with fund companies that offer the so-called low-load funds. If you are a registered investment advisor (RIA), you may not be affiliated with a broker-dealer and may offer only "managed money" accounts (using no-load funds).

For the rest of you, here are some things to consider when choosing among "A," "B" and "C" shares. You need to do a thorough fact-finding and needs analysis to determine the source of the money to be invested, if there will be more investable assets in the future, the client's needs and goals and if other family members have assets to invest.

You need to be aware of several things regardless of the type of shares you recommend. First, make sure the funds are on your broker-dealer's list of selling agreements. Second, if the person or immediate family members have money in a mutual fund family, there may be significant sales charge reductions available for new investments. Third, never sell just below the break point. If a person has $80,000 to invest from a pension rollover and you suggest putting half into one fund family and the other half into another fund family, you have probably committed a securities violation. The client would probably save money by buying "A" shares from a single fund. If you use "B" shares in both fund families to avoid the up-front sales charge, you are probably still "selling the break point." Fourth, ask yourself if there will be enough future investment to warrant a "rights-of-accumulation" election to reduce sales charges.

If your client is investing less than $50,000 ($25,000 in some mutual fund families), you could do several things. If you are sure, based on your suitability assessment and fact-finding, that the client has no potential additional funds to invest, you could allocate the money within one family or among several fund families. You might consider "B" shares since the net cost to the client should be a wash and most people feel better if they don't see 5 percent to 5.5 percent or so taken off the top.

If your client has, or is expected to have, more than $50,000 but less than $100,000 to invest, you need to be aware of "selling the break point" and you probably should put all the money into a well-diversified mutual fund family. The real decision is between "A" and "B" shares. Because there is a reduced sales charge for amounts over $50,000 ($25,000 in some funds), you should consider obtaining a "waiver-and-hold-harmless" agreement if you recommend "B" shares. Your commission is close to the same in both cases. Your broker-dealer probably has guidelines and advice for selling "B" shares in this case.

If your client has $100,000 or more, your broker-dealer almost certainly has rules about using "A" or "C" shares. If your client insists on not paying an up-front sales charge, you will need broker-dealer authorization, a letter from the client and a "waiver-and-hold-harmless" agreement at a minimum. "C" shares offer you the opportunity to manage your client's investments in a way normally used by RIAs. Your client pays an up-front sales charge (normally 1 percent) and ongoing fees of 1 percent a year (12b-1/management fees). In some fund families, this 1 percent fee is eliminated eventually; in others, it is not. You are paid trailers based on the 1 percent fee.

If "A" shares are used, one way to further reduce your client's costs is to put the investment into a bond fund with a lower sales charge and then move the money to the equity-based investments in the same fund family over a period of time.

Each class of shares has its advantages and disadvantages. "C" shares are particularly appealing if you are building a stream of trailers for retirement income, and they can also benefit your client. During the first year, there is normally a 1 percent surrender charge, but no surrender charges in subsequent years. This makes it simpler to manage your client's investments. You can move the investment to another fund family after the first year without running afoul of securities laws, your client pays a minimal up-front sales charge and you build a stream of retirement income. "A" shares are useful for the client willing to pay up-front for services. For investments of $100,000 or more, "B" shares should not be considered.

Janet C. Arrowood is a registered representative with The Leaders Group, Inc., member NASD, SIPC. She can be reached by email at jc_arrow@hotmail.com.

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