OK. You tell your clients youre a financial advisor and you will help them manage their money, develop a financial plan, and generally organize their financial lives. Since this column is about managing money, lets look at the four most common ways of doing just that, using mutual funds.
First, you can take the appropriate tests, file the right paperwork and become a registered investment advisor (RIA). Then you can charge fees for financial plans and advice and fees to manage money, use no-load funds and trade stocks and bonds. But thats a topic for another time
Second, third and fourth, you can use some of the various types of mutual funds available (A, B or C shares) and advise your clients about the most suitable ways to allocate their funds and direct future investments and rollovers.
However, if youre not currently working under the RIA umbrella, you cant charge a fee for advice. So, which share type or types make the most sense? Let us explore the A, B and C shares.
NASD expects you to put your clients interests above yours.
A shares can make a lot of sense if your client is dollar-cost averaging small sums of money into funds or if there is a substantial ($100,000 or larger) rollover or transfer of funds involved. Because the sales charges are up front and drop at each breakpoint, your client can save a lot of money in fees and will know exactly how much money is in his account at the end of each trading day. If your client plans to invest a substantial amount over the next 13 months, rights of accumulation can greatly reduce the up-front sales charges, too. However, very few people are happy paying 2.5 percent to 5.5 percent up front, even though they value your advice and relationship. And because your trailing commissions are a fraction of a fraction of a percent, you dont have a great financial incentive to manage the money.
Many financial advisors have turned to B shares to generate a relatively large up-front commission without the immediately obvious reduction in the invested amount that occurs with A shares. The regulatory agencies have essentially said that for investments of $100,000 or more in a 13-month period, A shares should not be used. Many broker-dealers have taken this even further and wont allow B shares for amounts of $50,000 or more. With B shares, there is a contingent deferred sales charge that declines over time. Nonetheless, your client doesnt know exactly how much would pay out if the account were closed on any given day.
C shares can be a happy compromise between becoming an RIA and always using front- or back-end load funds. The dilemma here is between the desire for the large pop of money with A or B shares, and small ongoing commissions, and the level amount of money (generally 1 percent) paid on C shares every year. Using C Shares creates far more incentive to actively manage your clients money. The only up-front expense to your client is during the honeymoon periodright when the account is set up. As far as your client can see, there is no future cost, so there is little incentive for him to keep his investments with you if you dont pay attention to him.
If you are relatively new to the business, the up-front commissions associated with A and B shares may be both tempting and necessary to your survival. It isnt easy to build a book of business on C shares during your first few years. Nonetheless, if you can earn enough from other business areas (annuities, insurance, etc.) to meet quotas or pay the bills, C shares are a great way to build a book of business and ensure consistent revenue without a constant hunt for new money. They also provide a real incentive to conduct annual reviews and stay in regular contact with your clients.
If you already have a decent book of clients with A and/or B shares, now might be a good time to start putting the future investments of both your existing and new clients in C shares. Just be careful if breakpoints or rights of accumulation are involved.
You may be tempted to move clients with A shares or those whose B shares have converted to A shares into C shares. Be very careful. Because front- or back-end sales charges have already been applied, this move may not be in your clients best interests. Remember that the NASD expects you to put your clients interests above yours, and a move from A or B shares to C shares may not fulfill that expectation. If you are planning to retire some day and maintain trailing commission payments, now may be the time to consider a shift to C shares.
Janet Arrowood is an Evergreen, Colo.-based freelance financial services writer. You can reach her at TheWriteSource@earthlink.net.