401(k) Predators: Don't Become Prey

In times of financial turmoil, people tend to look more closely into their retirement accounts. The last thing people need to worry about during difficult times is who is managing their accounts and how they are being managed - after all, isn't this why we pay our advisors?

However, although there are many capable and honest advisors available to help consumers swim the murky waters of their personal finances, there are also many 401(k) "predators", who strive mainly to enrich themselves with commissions and sales profits by encouraging those close to retirement to make inappropriate investments.

How can you protect your 401(k) from predatory advice? Read on to find out. (For background reading, see Find The Right Financial Advisor.)

Spotting a Rogue Advisor
Rogue advisors can be lurking in places you least expect. Be leery of organizations that come to your place of employment to give "free" financial educational sessions. Despite what you might think, management does not always approve these types of meetings. These organizations sometimes operate from your place of employment as a means of obtaining credibility, and these presentations are often just thinly disguised sales pitches; the goal is to get you to buy a particular financial product or service. Ask company management whether it is sponsoring any session that appears at your place of employment - if not, skip it.

The North American Securities Administrator Association (NASAA) is the oldest organization devoted to investor protection. Through this association, investors can find information and educational data to help protect themselves against fraudulent investment acts. Members of this organization participate in multistate enforcement action and information-sharing. In 2007, the NASAA released a report summarizing the results of investigative reports on the "free lunch" investment seminars. According to these results, seminars are indeed a target of unscrupulous investment advisors and more monitoring and regulation is needed to protect investors approaching retirement age. (For related reading, see Investigating The Securities Police.)

According to the NASAA, a great majority of the nation's consumer financial assets, valued at $16 trillion in 2008, are held by households headed by someone 50 years of age or older. The investments held by this segment of the population makes it a prime target for investment professionals seeking an increase in sales.

NASAA data indicates that although people aged 60 or older make up a very small portion of the U.S. population, they account for one-third of investment fraud victims. In addition, sales seminars have increased as a result of the increase in prospective clients within this age group. The results of the investigative report indicated that the "free lunch" seminars are commonly held in upscale hotels, restaurants, retirement communities and golf courses. The sponsors of these seminars offer incentives, such as door prizes, free books and vacation deals as a way to get individuals to attend. Invitations often pitch the "urgency" in reserving seats early because only "limited" seating is available.

Beware: Although these seminars are touted as educational sessions or workshops, the goal is to sell services or products, such as variable annuities, real estate, investment trusts, mutual funds and reverse mortgages, among others. Many financial advisors in these seminars offer biased product recommendations as a means to sell the products of the sponsoring companies. (Read Tips For Resolving Disputes With Your Financial Advisor and Common Concerns For Retirees to learn more about the NASAA's role in protecting investors.)

Trust Your Gut
It's important to trust your gut feeling when interacting with an advisor. Your financial advisor is the person who will guide you on one of the most sensitive issues of your life. As such, your finances should be placed in the hands of someone who can wholeheartedly dedicate him or herself to your best interests. Interacting with this person should give you a sense of comfort and clarity that enables you to understand your financial planning process and your investments. An advisor who rushes you out of the office and always seems too busy to call you back or answer your questions, or who doesn't give you straight answers, is not working in your best interest. (For related reading, see Is Your Broker Acting In Your Best Interest?)

There are several red flags you can look out for. When listening to an advisor making a pitch on a certain investment, look out for incredible promises. Guarantees of a high rate of return on your investments or talk about risk-free investments should set off alarms. Every investment has some type of risk involved and promises of a high return should be examined with scrutiny.

Some advisors go as far as to guarantee an 18% return; however, any investment with a high return will have high risk attached to it or loads of fees from which the advisor will make commissions. Make sure you look into the reason why the high return is expected and look closely at the fees involved. Before you sign up with any advisor, request a copy of the fee structure and account agreement - disproportionate fees can cut into your investments and decrease any profits gained, so you should avoid them. Look over the details carefully and at your own pace. When you are shopping around for an advisor, if you come across someone who pushes too hard for you to open an account, this could be a sign of someone who is just looking to make money, not help you improve your financial position. (Larger rewards always come with increased risk. Read Determining Risk And The Risk Pyramid to figure out where you fit on this scale.)

According to the Financial Industry Regulatory Authority (FINRA), the largest independent regulator for all securities firms doing business in the U.S., brokers can't guarantee high rates of return because this leads to unrealistic expectations. (Be sure to read the answer to our frequently asked question How does the FINRA differ from the SEC? to learn more about this organization.)

Investment Advisors Meet Financial Advisors
It's important to know the difference between an investment advisor and a financial advisor. According to the FINRA, an investment advisor is paid by providing recommendations about securities. These individuals are registered and regulated by the SEC if they manage $25 million or more of client assets or by state securities regulators if the advisor manages less than $25 million. A financial advisor is a more generic term that could refer to a broker or someone who, in addition to investment advice, offers financial planning services or only financial planning advice.

Choosing a Non-Rogue Advisor
There are several ways to find a qualified candidate. Word of mouth is one way; through contact with friends, neighbors, family members or colleagues, you might be able to locate someone who is trustworthy and meets your financial needs. Your employer could also be a source of information, providing you with a list of advisors it refers employees to. Other sources include trade organizations, labor unions, and local consumer or investment groups.

You can also interview prospective candidates. Ask questions like:

  1. How much experience do you have?
  2. How will investment performance be communicated to me?
  3. Have you ever had a professional licensed revoked?

These are the types of questions that get to the point and help you decide on the person you want for the job. (Be sure to read Shopping For A Financial Advisor to learn more about how to approach this sometimes daunting task.)

The FINRA also provides information to help you decide on a candidate. The FINRA website provides investors with a tool called the BrokerCheck which enables investors to check the background of an investment professional or a securities firm. BrokerCheck also allows investors to search an advisor's background, including his or her current employer, 10-year employment history, all approved licenses and registration, criminal felony charges and convictions, and investment-related misdemeanor charges and convictions.

The Bottom Line
Selecting the right advisor can turn out to be a the best decision you make for yourself and your family. Look at all your choices carefully and never make this type of decision in haste. Taking your time to look closely at all the details will help pave the way to solid financial future.