Systematic Investment Plans—Educate Yourself Before You Enlist
Investing money each month is a great way to build a nest egg—but not all monthly investment programs are created equal. For a specific type of systematic investment plan—sometimes referred to as a "contractual plan" or "periodic payment plan"—an investor must make a long-term commitment of 10 or 15 years. While the majority of these plans are sold to military personnel, they are also sold to civilians. These plans come with high upfront costs and are expensive if the full term of payment is not completed.
We are issuing this Alert to inform investors, especially those serving in our armed forces, of the costs and risks involved in such plans. The Alert is issued in conjunction with an Enforcement Action, in which sanctions were levied against a brokerage firm selling these plans to military personnel.
If you are approached about investing in the type of systematic investment plan described in this Alert, read the prospectus carefully. Clearly understand the costs and risks before you invest. Never feel compelled or pressured to invest.
Legislation Prohibits Future Sales of Systematic Investment Plans
On September 29, 2006 the President signed into law the Military Personnel Financial Services Protection Act, which made it unlawful to issue or sell any periodic payment plan 30 days after the signing date. The bill, however, does not invalidate plans sold prior to the enactment of the legislation.
What are Systematic Investment Plans?
This Alert focuses on systematic investment plans that are regulated as "periodic investment plans" under the federal securities laws. These plans allow you to accumulate shares of a mutual fund indirectly by making small regular monthly payments, usually as little as $50, over a period of 10, 15 or 25 years. Individual plans can differ from one another. But in general, there are a number of common characteristics that you should be aware of before investing:
- High first-year cost. You are required to pay a creation and sales charge equal to as much as 50 percent of the first 12 monthly investments. In other words, if you invest $100 per month for the first 12 months of the plan, $600 of your $1200 investment goes toward the creation and sales charge in such a plan. Moreover, if you increase the amount of your monthly payments, you may owe an additional creation and sales charge on the new investment. This charge will be deducted from your next 12 monthly payments.
- Long-term investment. Typically, systematic investment plans require 180 fixed monthly payments over a 15-year period, with the option of making payments for up to 25 years (300 investments). While you are not required to complete the plan, if you terminate the plan prior to expiration or stop making payments, you could pay a sales charge up to 50 percent of the amount invested, depending on how many payments you have made to the plan. For example, if you make 12 payments or less and hold the plan beyond the cancellation limit (described below) your sales charge could be as high as 50 percent of the amount invested.
- No direct mutual fund ownership. If you invest in a systematic investment plan, you do not directly own shares in a mutual fund. Instead, you own an interest in a trust. The trust invests your regular payments, minus fees and expenses, in shares of a mutual fund.
- Fees and expenses. Most plans have three types of fees:
- Creation and Sales Charge. As we've discussed, you are required to pay a creation and sales charge equal to as much as 50 percent of the first 12 monthly investments. After the first 12 monthly payments, some plans impose a reduced sales charge, but many plans do not impose any sales charge on the remaining payments under the term of the plan. If you complete the 15-year term, the sales charge can be effectively reduced to as little as 3.3 percent of all investments made, and may be effectively reduced further if you extend the term of the plan beyond 15 years. You may be able to reduce the creation and sales charge further if you increase the face amount of the plan and make larger monthly investments (usually $1,500 or more) or you can combine your plan investment with other plans that you or certain family members make through your plan sponsor. Even if these discounts are realized, the high creation and sales charge associated with your first 12 investments makes these plans expensive in the short-run.
- Mutual Fund Expenses. In addition to a creation and sales charge, you will indirectly pay annual mutual fund operating expenses for the mutual fund shares held by the plan trust, which can include management fees, 12b-1 fees (covering sales and distribution expenses), and other expenses.
- Custodial and Service Fees. Most plans charge various custodial and services fees. These fees may include a monthly plan investment processing fee, a termination fee, an inactive account fee, a bank wire fee, a bad check fee, and an IRA custodial fee (if you hold your plan as an IRA)
- Cancellation and Refund Rights. You can cancel your plan as follows:
- 45-Day Cancellation Right. You will receive a notice of your cancellation rights within 60 days after your first investment in the plan. You can cancel your plan within 45 days of the mailing date of that notice. If you choose to cancel your plan, you will receive a cash refund equal to (1) the current value of your investment and (2) the total sales and creation charge you paid. The current value of your shares may be more or less than your original investment.
- 18-Month Cancellation Right. You are also able cancel the plan within 18 months after your first investment in the plan. If you choose to cancel your plan after the 45-day cancellation period, you will receive a cash refund equal to (1) the current value of your investment and (2) the amount of the sales and creation charge you paid that exceeds 15 percent of the total investments you've made in the plan. You should receive a notice of your 18-month cancellation right if you miss (1) three or more of your monthly investment payments during the first 15 months of the plan or (2) one or more payments after the first 15 months.
If you cancel your plan after 18 months, you will not be entitled to a refund of any creation and sales charge. This charge can be up to 50 percent of your periodic investments.
- Missed Payments. The sponsor may terminate your plan if you fail to make investments for a period of 6 or 12 consecutive months. Depending on the plan, you may be able to avoid termination by making at least one monthly payment during each 6 or 12-month period.
You should read the individual prospectus associated with the plan you intend to purchase to understand the details regarding your specific purchase.
Beware of Misleading Claims
We found instances where the sales scripts and charts used to market systematic investment plans contained misleading statements and omissions about the following:
- the effectiveness of the 50 percent first-year sales load, claiming that this high upfront charge increased the likelihood that an investor would complete the plan, although the firm's data showed, for the sales made between 1980 and 1987, that only 43 percent of its customers completed 180 payments or more within 15 years;
- comparisons between the systematic plan and other mutual fund investments, including statements that no-load mutual funds were primarily for speculators and had some of the highest long-term costs; and,
- the availability of the Federal Government's Thrift Savings Plan ("TSP"), which offers military investors many of the same features of a systematic plan at lower costs.
See First Command Fined and Ordered to Pay $12 Million for Misleading Statements in Sales of Systematic Investment Plans to Military Personnel.
Dollar-Cost Averaging and Systematic Investment Plans
Systematic plans have been promoted as a way to dollar-cost average, a strategy of investing the same fixed dollar amount in the same investment at regular intervals over an extended period of time. When you dollar-cost average using the same amount each interval, you buy more shares of an investment when the share price is low and fewer shares when the share price is high, which can result in paying a lower average price per share. The dollar-cost averaging strategy doesn't try to time the market. Instead, it reduces the risk of investing a larger amount in an investment at an unfavorable time by spreading your investments out over a period of months, years, or even decades.
When using a systematic investment plan to dollar-cost invest, be aware:
- Systematic investment plans can be expensive over the short term. Because the creation and sales charge for a systematic investment plan can be as high as 50 percent of the plan's first 12 monthly payments, and remain at high levels if you terminate during the first 10 years, it can be more expensive than investing in other types of automatic investment programs. As the chart shows, the earlier you discontinue contributions to a systematic investment plan, the more expensive it is as a percentage of your total investment.
|Contributions Discontinued after:||Systematic Investment Plan Creation and Sales Charge as a Percentage of Amount Invested|
It is possible to find alternative dollar-cost averaging programs that cost significantly less in the short term.
- Systematic investment plans offer little flexibility. If you miss monthly payments, you may be terminated. Some plans also have restrictions associated with making investments ahead of schedule to complete a plan early. There are other automatic investment plan alternatives that do not require long-term fixed monthly payments, and most don't charge a fee for setting up or terminating your automatic investment program.
- Systematic investment plans offer limited investment choice. With a systematic investment plan, you have minimal opportunity to invest in anything other than the fund designated by the plan sponsor. By contrast, most retirement plans offer a cafeteria of investment options (the average 401(k) offers 15 different investment alternatives). And most mutual funds allow you to invest in other mutual funds that are part of the same fund family, enabling you to move out of a fund when the fund loses a manager, raises its expenses, or no longer fits the risk profile you seek.
Other Dollar-Cost Averaging Alternatives
When it comes to dollar-cost averaging, investors have options other than systematic investment plans. These alternatives tend to offer greater flexibility than systematic investment plans and generally do not charge a fee for setting up or terminating automated transfers of funds.
- Mutual funds provide vehicles for implementing the dollar-cost averaging strategy. Some funds waive initial deposits and allow investments of as little as $50 per month. Call around. Inform the mutual fund company of your desire to invest monthly and how much you feel capable of investing.
- If your goal is to save for retirement, most employer savings and retirement plans allow you to save through payroll deduction. Military personnel can make long-term periodic investments in the U.S. Thrift Savings Plan. This plan has no up-front load and low on-going expenses. For more information go to the Thrift Savings Plan website.
- If your objective is to save for college, 529 plans offer flexible minimum contribution limits. Many require a $250 initial contribution with subsequent monthly contributions of as little as $50. For more information see Smart Saving For College brochure.
- A number of securities firms and investor organizations offer low-cost incremental investment plans that allow customers or members to invest in a variety of stocks, exchange traded funds and mutual funds. Some charge a percentage of each incremental investment, while others charge a flat fee per transaction.
- Some public companies offer direct stock purchasing plans (DSP) and dividend reinvestment programs (DRIPS) that allow investors to purchase shares or partial shares of stock on a monthly basis, as well as automatically reinvest stock dividends. You can find out more about DSPs and DRIPS on the Securities and Exchange Commission's website and by contacting a company's Investor Relations Department or visiting the Investor Relations area of the company's website.
Former First Command customers were eligible to receive restitution of a portion of sales loads they paid in the purchase of systematic investment plans.
Before you put money into a systematic investment plan, take charge of the decision-making process:
- Understand the investment. Rely on the prospectus, not on sales literature and presentation information alone to make your decision.
- Make sure the product meets your investment objectives and is suited to your financial situation, future goals and risk tolerance.
- Can you follow through with long-term monthly payments? Many people can't. If there's a chance you will terminate the plan or withdraw money from it in the short-term-10 years or less-a systematic investment plan may not be for you.
- Know how much you will pay in fees and expenses. Ask your broker whether you will pay a sales load, and how much you will pay in annual expenses. Use FINRA's Fund Analyzer to help you compare sales loads, fees, and other expenses.
- Understand the plan's cancellation policy and what it means to your investment.
- Research investment alternatives such as mutual funds and your employer's retirement plan.
- Investigate your broker and securities firm. Use FINRA BrokerCheck to check the background of your investment professional and firm.
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