My financial advisor has me invested in the best fund

A friend tells me of his investments

Financial advisors are used regularly by ordinary folk looking to increase their returns. But is it always a good idea?

My financial advisor has me invested in the best fund! This is the line I heard from a friend. Needless to say it peaked my interest. I asked the friend what this investment was.

It turns out that his financial advisor had recommended the fund as an incredible fund that was aimed to create outperformance. I enquired as to what it was supposed to outperform however my friend was unable to tell me. I asked what the fund was invested in and unfortunately he was unable to tell me. I then asked how much the fund was costing him. My friend excitedly responded that it didn't cost anything in terms of a fee as the costs were deducted from the investment growth! He explained that 5% of everything that he puts in is deducted as a charge and 1.8% annual management fee is deducted from the investment.

5% of the initial investment and 1.8% annual management charge is a ridiculously high fee even by industry standards! My friend was comforted by the fact that he thought it was realistic to have gains every year sufficient to cover these costs and then some.

What are the fund returns?

What was more worrying other than the fees was the fact that my friend wasn't sure what he was invested in. Where did he think he returns were coming from? On what basis did he determine that the fund was a good long term investment? 

I'm convinced that the only reason that he is invested in the fund is due to the financial advisor having a very good sales patter. The cynic in me would suggest that this particular fund pays a very high commission to the financial advisor for recommending it. I can't think of any other reason as to why the charges would be so high - there are extremely limited funds in the world that could demonstrate a long term growth track record in order to justify the fees.

What can we learn from this investment story?

We learn several things:
1) know what you're invested in. If the financial advisor cannot explain the contents of the fund in simple terms then steer clear of it.
2) what out for the charges. These can quickly eat away at your returns. Make sure to compare between lots of funds with different charge levels. Ask the fund manager to inform you of those funds with cheaper fee structures and ask why they aren't recommending those to you.
3) question what is in it for the financial advisor. How are they motivated? Do they have your best interests to heart?

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