Josephine Norton
Investing in proprietary funds is a bad idea for several reasons. Firstly, they are typically very expensive, with high fees that can eat into investment returns. Secondly, they often underperform when compared to other funds, resulting in lower investment gains. Thirdly, there is a conflict of interest when brokers or advisors recommend proprietary funds as they may be incentivized by their firm to do so, rather than acting in their client's best interests. Additionally, proprietary funds may not offer the same level of diversification as third-party funds, and they may also have transferability issues, with additional costs incurred when moving funds between firms. Overall, investors should be cautious when considering proprietary funds and carefully evaluate fees, performance, and potential conflicts of interest before making any investment decisions.
| Characteristics | Values |
|---|---|
| Conflict of interest | Salespeople or advisors may be incentivized to recommend their own products over others |
| Expensive | Fees are often very high |
| Poor performance | 64% of proprietary funds failed to keep up with their respective index |
| Lack of transparency | It's not always clear which funds are proprietary as 401k providers often use subsidiaries to mask the nature of a fund |
| Lack of choice | Narrows your investment choices considerably |
| Lack of diversification | May not offer an international growth fund, for example |
| Lack of transferability | Units of the in-house funds will have to be sold if an investor wants to move their account |
What You'll Learn
They are expensive
Proprietary funds are often more expensive than other funds. This is because they are created and managed by the 401k provider, who has a conflict of interest. The salesperson or advisor to the 401k plan may be incentivised to recommend their own products over others, receiving compensation through commissions and kickbacks.
For example, if you invested $10,000 ten years ago with the Principal 2040 fund, you would have paid 829% more in fees while earning 23% less in investment returns versus the fees and performance of the Vanguard 2040 fund.
The fees associated with funds vary more than the performance of the funds. These fees can range from 0.15% to as high as 2.5% and can add up to a large sum for the brokerage firm.
In addition, proprietary funds may not be transferable from one firm to another. If an investor wants to move their account, the units of the in-house funds will have to be sold, resulting in additional fees, commissions, and administrative costs.
It is important to note that not all proprietary funds are bad funds. Some of them have solid performance. However, it is crucial to evaluate the fees and compare them with other funds to ensure you are getting a good deal.
Mutual Fund Investment: Strategies for Success
You may want to see also
They perform poorly
Proprietary funds are mutual funds that are owned and managed by a brokerage firm or financial custodian. They are often created and managed by a 401k provider or the company that services your plan.
Performance-wise, proprietary funds tend to fall short. According to the US News and World Report, 64% of the proprietary funds they looked at failed to keep up with their respective index.
A comparison of two target date 2040 funds with similar investment objectives showed that if you invested $10,000 ten years ago with the Principal 2040 fund, you would have paid 829% more in fees while earning 23% less in investment returns versus the fees and performance of the Vanguard 2040 fund.
A 2012 paper by professors from prominent universities also studied this issue. They found that:
> poorly performing funds are less likely to be removed from and more likely to be added to a 401(k) menu if they are affiliated with the plan trustee. We find no evidence that plan participants undo this affiliation bias through their investment choices. Finally, the subsequent performance of these poorly performing funds indicates that these trustee decisions are not information-driven and are costly to retirement savers.
The paper went on to detail the amount of underperformance of these funds.
In summary, proprietary funds tend to perform poorly due to the inherent conflict of interest and higher fees involved. This can result in lagging performances and higher costs for investors.
SP 500 Index Funds: A Smart Investment Choice
You may want to see also
They incentivise advisors to put their interests ahead of their clients'
Proprietary funds are investment funds created and managed by a 401k provider or brokerage firm. They are often incentivised to recommend their own products over others through commissions and kickbacks. This creates a conflict of interest, as advisors may be compensated based on the products their clients choose. This means that advisors may put their interests ahead of their clients' interests.
A study by Credo Consulting found that financial advisors used their own related/affiliated companies' products far more frequently than could have been expected by chance. National Bank advisors recommended National Bank funds to 62% of their clients, while the likelihood of a randomly selected investor owning National Bank funds was only 4.8%. This means that a client of National Bank was around 13 times more likely to own National Bank products than the average investor.
The Financial Industry Regulatory Authority (FINRA) has made it illegal to use sales incentives for the sale of proprietary funds, as it gives brokers a financial reason to prioritise their own interests over those of their clients. However, some firms may still have incentives in place that do not meet the spirit of the underlying rules. As a result, some advisors and customers refuse to buy or offer in-house funds to avoid any appearance of indiscretion.
When considering proprietary funds, it is important to compare fees and ensure that the advisor is not prioritising their own interests over those of their client.
Loaded Fee Mutual Funds: When to Invest and Why
You may want to see also
They are not easily transferable
Proprietary funds are not easily transferable. This is because they are typically tied to the brokerage firm or financial institution that offers them. If an investor wants to move their account to another firm, they may need to sell their units in the proprietary fund, which can result in additional fees, commissions, and administrative costs. There is also market risk associated with selling the mutual funds and reinvesting the proceeds. It is important to note that firms may not always disclose the portability restrictions of their proprietary funds to their clients.
The lack of transferability can limit investors' options and flexibility when managing their investments. It may also create a conflict of interest, as financial advisors or brokers may be incentivized to recommend their own proprietary funds over other investment options that may better suit the client's needs. This can result in clients being steered towards investments that may not be in their best interest.
To address this issue, the Financial Industry Regulatory Authority (FINRA) has outlawed the use of sales incentives for the sale of proprietary funds. However, some firms may still have incentives in place that do not meet the spirit of the underlying rules. As a result, some advisors and customers choose to avoid in-house funds altogether to eliminate any potential for indiscretion.
It is crucial for investors to carefully research and understand the restrictions and potential costs associated with proprietary funds before making any investment decisions. By doing so, they can make informed choices that align with their financial goals and risk tolerance.
Mutual Funds vs ULIPs: Where Should You Invest Your Money?
You may want to see also
They may not offer the type of fund or style you desire
Proprietary funds are investment funds that are created and managed by the 401k provider or brokerage firm. They are often more expensive than other funds, with higher fees, and perform poorly in comparison.
When considering investing in a proprietary fund, it is important to be aware that they may not offer the type of fund or style that you desire. This is because they are created and managed by the same entity, meaning that they may not align with your specific financial goals or risk tolerance.
For example, let's say you are interested in investing in a particular sector or industry, such as renewable energy or healthcare. A proprietary fund offered by your brokerage firm may not have a focus on these areas. Instead, it might be a more general fund that invests in a broad range of industries. This lack of specialization could be a disadvantage if you are looking to target your investments towards specific sectors or themes.
Additionally, proprietary funds may not offer the level of risk or return that you are seeking. Different investors have different risk tolerances, and proprietary funds might not match your specific risk profile. Some investors are comfortable with taking on more risk in exchange for the potential for higher returns, while others prefer a more conservative approach with a focus on capital preservation.
Furthermore, proprietary funds are often managed by the same institution that created them, which can lead to a conflict of interest. The advisors or salespeople associated with these funds may be incentivized to recommend their own products over others, potentially prioritizing their own gains over your best interests.
To summarize, when considering investing in a proprietary fund, it is important to keep in mind that they may not align with your specific financial goals, risk tolerance, or desired level of specialization. Conduct thorough research, compare fees and performance with alternative funds, and seek independent financial advice to ensure that any investment decisions are well-informed and suited to your individual needs.
Investment Funds vs Savings Accounts: Where Lies the Risk?
You may want to see also
Frequently asked questions
A proprietary fund is a mutual fund that is owned and managed by your brokerage firm or financial custodian.
Brokerage firms offer proprietary funds for the money. They charge annual fees ranging from 0.15% to 2.5% which can amount to a large sum.
The salesperson or advisor to your 401k plan may be incentivized to recommend their own products over others. They may receive compensation through commissions and kickbacks.
According to the US News and World Report, 64% of the proprietary funds they looked at failed to keep up with their respective index.
Proprietary funds may not offer the type of fund or style you desire. They may also have higher costs due to a lack of economies of scale and may not be transferable from one firm to another.
