I’ve heard a variation of the above statement five times within the last year.  I’ve had enough.

You know the saying, if it’s too good to be true it probably is.

“I usually charge 2.5% of the home listing price, but for you, I’ll do it for free.”

“I had to order these parts special from Germany, they usually fetch a few thousand each, but for you, they’re free.”

“We usually never reimburse for elective surgeries, but for you, it’s free.”

Can you imagine?

At the very least, we would take a minute to question our good fortune or ask what’s the catch.

So why do we happily accept when our financial advisor says, “I need to put food on the table, but for you, I won’t charge a fee.”

There is no such thing as a free lunch.  This is especially true for our sales-driven advisor that works for a publicly traded company.

Here’s how the no-fee advisor pulls it off:

The broker convinces the unsuspecting client to pay a “one-time” mutual fund sales load up front.  The sales load can be as high as 5.75% and compensates the broker.  The broker usually follows up with a graph showing the investor saving money by paying the upfront sales load versus an annual percentage of assets fee (typically 1% per year).  The broker reiterates he or she will not charge an ongoing fee for their services.

A year passes and lo and behold, the broker doesn’t directly charge the client a fee.  However, the mutual fund company is charging you ~1.08% (Morningstar reports the average mutual fund expense is 1.08% per year) annually.  The fee is taken daily so you won’t notice.  The mutual fund expense fee will never show up on your statement and your broker will never talk about it.

What’s in it for the broker you might ask?

The mutual fund pays the broker a trailing commission or kick-back.  As long as you stay invested in the fund, the broker gets their recurring commission.  From the broker’s perspective, since they aren’t charging you a fee directly, they have little incentive to service you.  They can focus on pouncing on their next prey.

Here’s an example.  Let’s assume an $100,000 investment.

Mutual Fund Sales Load:

$100,000 x 5.75% Sales load = $5,750 commission to the broker.  Our initial investment of $100,000 is now $94,250*.

Annual Mutual Fund Expense:

$94,250 x 1.08% Mutual Fund Expense Ratio = $1,017.90

The broker is paid a percentage of the annual mutual fund expense ratio.  In this case, a percentage of the $1,017.90.

It’s true that technically your broker isn’t directly charging you a fee, but wouldn’t you concede this to be offensively misleading?

The SEC is catching on to our “no fee” mutual fund slinging friends and doing something about it.  According to Sarah O’Brien of CNBC, the SEC is giving investment firms a pass on fines if they come clean by June 12th, 2018 (essentially admitting they put clients in high-fee mutual fund shares).  Offending firms are even required to reimburse clients for the higher fees and any gains they missed out on.

If it’s too good to be true, it probably is.

*Mutual fund sales-loads often have breakpoints for larger investment amounts.  A breakpoint scale might look like this:

Less than $25,000: 5.00%

At least $25,000, but less than $50,000: 4.25%

At least $50,000, but less than $100,000: 3.75%

At least $100,000, but less than $250,000: 3.25%

At least $250,000, but less than $500,000: 2.75%

At least $500,000, but less than $1 million: 2.00%

Source: Investopedia