Be Careful Where You Get Advice

I had a client call me today with concern about her mother. Her 87 year old mom had gone to the bank to take care of a CD that had come due. She was greeted by one of the bank’s licensed bankers or financial advisors.

Now let me say this up-front. Either the financial advisor completely did not understand the products that she was representing or she was real hungry for a product sale and would do anything for it. As you read this story, I think that you will agree that either way it is disturbing.

So the financial advisor says to the elderly lady, “You don’t want to get back into another CD. The CD is paying very little in interest. Plus it is not FDIC insured. (Which is actually incorrect – it was at a FDIC bank and under $ 100.000) Let me show you something else.” She then proceeds to pull out information on a bond mutual fund.

The advisor says, “This fund pays a dividend of 5.84% which is much higher than what a CD is paying and IT IS INSURED.”

Now I cannot imagine how she came to that conclusion. Maybe she thought that some of the bonds inside of the bond fund were insured and that made it insured in her eyes. Certainly, she did not mean to imply that it was FDIC insured. On top of that, she didn’t explain that there would be up-front fees.

Even though much of what I had heard was troublesome, the worst of this recommendation had not even been told to me yet.

This advisor wanted to put this 87 year old lady into a High Yield Municipal Bond Fund. First, regardless of age, you want to avoid high yield anything. High yield is another word for high risk. Guess what category of bonds is having problems with all of these credit and mortgage issues? You got it – High Yield.

In fact, this particular bond fund has 15 to 20% invested into housing related bonds. In other words, this fund has approximately 15% of potentially worthless bonds.

Second, municipalities are having a tough time right now and I sure wouldn’t want to be holding a bunch of municipal bonds (Read: municipal debt.)

I tell you this story to highlight two points. First, there are sales people disguised as financial advisors giving very bad advice. There are potentially ones that are telling outright lies. It happens and be careful who you trust. Of course, there are also some outstanding financial advisors giving good advice. The problem is that sometimes it is difficult to tell the two apart. The ability to sale, lack of morals, and a high likeability factor is a dangerous combination.

Second, it is important to understand how bond funds work. Typically you buy a single issue of a bond for a specific time period. During that time period, the bond issuer pays a quarterly dividend. At the end of that term, you are intended to get your money back. There is a safety net in most situations.

In a bond fund, there is no safety net and you can lose a good amount of money. It does happen. Although they can pay good dividend rates and can be attractive considering the miserable rates paid on CD’s and money markets, they can lose value making the dividend not such a great benefit.

Be careful when taking advice and make sure that you know you are talking to a qualified and ethical advisor before making any changes with your money.