Here Are The 5 Biggest Financial Rip-Offs To Avoid

Ripping a band-aid off a wound that hasn’t completely healed hurts. Ripping duct tape off your unshaven face? Now, that’s painful.

But, do you know what hurts even more?

Getting ripped off — that’s what.

There’s nothing worse than getting ripped off and losing your money on an investment you should have never bought in the first place. This is especially true when you trusted someone to sell you a financial product and they betrayed your trust by selling you something you didn’t need that earned them a huge commission.

As someone who has been working as a financial advisor for many years, I’ve seen so many people who have purchased investments that didn’t make sense for their lives. Usually it’s because their advisor was shady and commission-hungry to the point where they were willing to sell them some bloated, high-cost investment they didn’t even need.

With this in mind, my goal is saving you, the investor, from purchasing investments you probably won’t benefit from. Here are the five biggest investment rip-offs most people should avoid:

#1: Loaded Mutual Funds (A Shares)

Loaded mutual funds are funds that, when sold, help financial advisors earn huge upfront commissions. They sell you the product and they get paid right away whether the funds work out well for you or not.

One good example of a fund that falls into this category is the Growth Fund of America from American Funds. I’m not singling out this fund or American Funds for any reason other than the fact this is one of the most commonly sold loaded mutual funds by commissioned brokers out there.

And, it’s pretty obvious to see why this happens when you find out just how much financial advisors can earn. If you invest into this fund with less than $25,000, you are going to pay 5.75% upfront as a commission.

Let’s do the math and say you were investing $20,000 into this fund. You would have to pay $1,150 of that amount to the advisor that sold it to you.

Mutual fund companies will justify this by saying they give you a discount if you are able to invest bigger amounts. If you invest $25,000 to $50,000 in this fund, for example, your upfront commission charge drops from 5.75% to 5%.

As if that’s something to be excited about, right?

Even grosser is the fact that advisors will tell you that you can move your fund into another fund within that family. You can do that as much as you want without the sales charge, they say, which makes it seem like such a good deal!

The problem is, you will have to pay another upfront commission if you move your fund to a different fund family.

Mutual fund companies argue that you’ll pay lower expenses on these funds the longer you hold them. While there is some truth to that, you have to consider how long you’re actually going to hold this fund.

Forever? Probably not.

Keep in mind that I’m not picking on American Funds specifically. There are a lot of mutual fund companies that charge huge upfront commissions, but it’s up to you — the investor — to ask the right questions and sniff them out.

#2: Actively Managed Index Funds

While not all actively managed mutual funds pose a problem, there is one type of actively managed fund I want to pick on today — actively managed index funds. If you know anything about investing, you know that many people buy index funds to keep their investing game simple and keep their costs low.

Keep in mind that many, if not most, index funds are extremely cheap to buy and maintain. As an example, the Fidelity 500 Index Fund comes with an expense ratio of .09%! We’re talking about paying next to nothing to have a broadly diversified investment.

For whatever reason though, there are mutual fund companies out there offering actively managed index funds. This increases the cost of these funds for no reason at all.

Financial advisor David Wilson, who blogs at Financial Truths, believes there are scenarios where it makes sense to invest in actively managed funds. After all, there are research departments and managers who are paid to make investment decisions.

But since an index fund simply mirrors an index, there are very few management decisions to be made.

“So, when a fund company charges higher fees for an index fund, they're asking you to pay something for nothing,” Wilson told me. “It just doesn't make sense.”

#3: Non-traded REITs (Real Estate Investment Trusts)

If you’ve ever read an article or watched a YouTube video where I talked about how to get started as a real estate investor, you’ve probably noticed I mention REITs as a plausible option. That’s because, for the most part, I consider REITs to be solid investments.

The thing is, there’s a type of REIT I’m not big on recommending — non-traded REITs. When it comes to non-traded REITs, there’s one word you should become acquainted with — illiquid.

What does this mean? When you need your money back out of a non-traded REIT, you can’t get it out until the investment runs its course. This could be ten years or longer depending on the non-traded REIT you buy.

This can be a bad deal for investors who aren’t exactly sure of their investment timeline. Obviously, having your cash tied up for a decade or longer poses some financial risk as well.

At the end of the day, there’s no reason to buy non-traded REITs when there are other REITs and other investments to consider that make it much easier to liquidate your investments if needed.

The Financial Industry Regulatory Authority (FINRA) even lists the risks of non-traded REITs on their website. Some of the threats they warn about include:

The fact that distributions are not guaranteed and may exceed cash flow

Non-traded REITs have no public trading market

Early redemption of non-traded REITs is often expensive and overly restrictive

Non-traded REITs can be expensive, and many charge two tiers of fees — an upfront commission that cannot exceed 10 percent of the sale and additional upfront “issuer costs”

Properties purchased in a non-traded REIT may never be specified

As Benjamin Brandt, financial advisor and host of retirement podcast Retirement Starts Today Radio, said recently, there are hundreds of investment options available today with the mandatory transparency needed to be listed on an exchange. However, non-traded REITs add “unneeded complexity without enough transparency to know what you own.”

But, once again, advisors sell non-traded REITs to get the huge, upfront commissions. If you’re surprised by that, you haven’t been paying attention.

#4: Whole life insurance

Sure, there are scenarios where buying whole life can make sense, but there are way too many situations where whole life is sold to consumers who don’t need it. I have been a financial advisor for a long time, and I can’t think of a single time where I saw a client with a whole life insurance policy I felt was right for them and their needs.

Unfortunately, the huge commissions agents get for selling these policies are enough to get them to sell them to parties who would be better off with cheaper coverage. What really sucks is that, many times, whole life is sold to people who aren’t saving enough for retirement and haven’t even opened a Roth IRA — people who would be much better off getting their financial ducks in a row instead of buying an overpriced, bloated whole life policy.

But, how much more do these policies cost? To come up with an example, I priced out a $250,000 term life insurance policy for a thirty-year old male in good health. For a term policy, the premium worked out to $21 per month. To get the same amount of whole life insurance, on the other hand, the monthly premium worked out to $286 per month!

Just think about that. If you’re 30 years old, where will your money be better spent? Saving for retirement or buying whole life insurance? I think you know the answer to that.

Please, whatever you do, buy a term life insurance policy. It’s so much cheaper!

Unfortunately, a lot of insurance salesmen tell buyers that their whole life policy is some sort of investment or savings account. And they’ll even talk about the dividends they pay. But, you have to keep in mind that the dividend figures they quote are gross and not net. Yes, they might pay a dividend of 5% or more, but you still have the cost of insurance that’s going to eat away those returns.

San Diego Financial Advisor Taylor Schulte told me that he feels similar about whole life as I do. In fact, he said that nothing makes him angrier than seeing someone with a whole life policy that isn’t what they need.

“They are expensive, wrongfully sold, and one of the biggest rip-off investments out there,” said Schulte. “Most people are better off buying low-cost term insurance and investing the difference.”

A life insurance agent I know named Chris Huntley even started the Whole Life Insurance Rebellion — a movement created to help consumers understand how much of a rip-off their whole life has become.

When it comes to whole life, the biggest proponents of these policies are the people who sell them.

#5: Indexed universal life insurance

If you have maxed out your 401(k), cannot contribute to a Roth IRA, and have your financial ducks in a row, then buying an indexed universal life insurance policy could make sense. But even then, it’s pretty questionable.

I cannot tell you how many times I’ve heard these policies referred to as a “Super Roth IRA.” This makes me crazy because this is a life insurance with an investment component. You do have the potential to secure a return based on the index your policy is tied to, but your return is typically capped. These caps can limit your return substantially, which is why these policies have limited upside.

One thing that makes me extra-crazy about indexed universal life is that I’ve heard advisors say, with a straight face, you should buy these policies before you open a Roth IRA or max out your 401(k). They will give you all these stats and facts to back up their advice, but none of it makes any sense.

The only thing guaranteed when you buy indexed universal life is that the person who sold it to you is going to see their bank account balance rise. Why? Because they made a huge commission for selling you a policy regardless of whether you needed it or whether you would have been better off with something else.

Final Thoughts

Unfortunately, there are so many investment scams and slimy salesmen out there that you have to pay close attention to avoid getting ripped off.

Before you invest your hard-earned cash, make sure you understand what you’re buying and, more importantly, why.