I’m writing this post because of an e-mail response I got from my friend JLP over at allthingsfinancialblog.com. First, let me point out that JLP runs an excellent blog- one of my favorites. I sent him an e-mail recently because he has a section on his site which links to others financial planners, specifically those who write blogs. I figured it would be appropriate to get a link on his site, being as how I’m a financial planner, a fellow blogger, and have a book coming out this summer with Wiley & Sons which features JLP along with about 70 other bloggers. But JLP asked me the ultimate question- a question which earns so much publicity that I could talk about it in my sleep- a question so great that it transcends time: do I earn commissions? Hesitantly, I explained that, while I’m predominately a fee-based advisor, my firm, as a comprehensive wealth manager, does earn commissions. I think I got a bit defensive and went on to explain in my e-mail some of the pro-bono work that my firm does. This morning when I sat down to write a post, it occurred to me that not every advisor who earns a commission needs to apologize for doing business this way. More importantly, I don’t think the average consumer truly understands what it means to be a fee-only financial advisor. Some advisors are touting their fee-based model of doing business when a commission could actually save their clients money. Allow me to disseminate the truth about this situation once and for all.
A “fee-only” advisor in its truest sense, should not be receiving asset-based fees. For example, take John Doe, a fee-only advisor who gets a 1.0 % annual fee for managing accounts. This means Mr. Doe gets $7,500 per year for managing a $750,000 portfolio- quite a sum! Now, the assumption is that the portfolio will avoid expensive funds by using low-cost index products along with individual stocks and bonds. However, if you really break it down, the client is not getting away even close to as cheaply as they could be. If John Doe were really crazy about costs, he’d visit a true fee-only advisor who would charge a flat rate, based on time, and produce a comprehensive financial plan or investment policy statement. Then he’d send the client off to a discount online brokerage to execute his trades. This would save the large majority of the above $7,500 fee. Some advisors do this (I’d estimate 5-10%) but most don’t simply because it’s much more difficult to make a living from writing financial plans. Plus, there are certain other complications that arise when trusting an online brokerage house with your retirement funds and other savings.
So now the question becomes, is earning an asset-based fee ethically superior to earning a commission? The answer to that is maybe, sometimes yes, sometimes no. I’ll explain why. When you earn a commission from an account, as the argument goes, you have no future incentive to continue servicing that account. Why should you spend two hours creating a report for a client who already paid the only commission which you will receive? You might as well get back on the phone and try to drum up some new accounts. This argument incorrectly assumes that all advisors are out for profit only and don't care at all about customer service. It also assumes that an advisor will try to push you into sneaky share classes which have deferred sales charges and all that yucky stuff. Is that true? Not at my firm... and I certainly hope not for the majority of advisors entering the profession. There are protective measures put into place by the NASD to ensure that unethical practices are as few and far between as possible. Also, part of the fee argument is that AUM fees (assets under management) are more ethical than commissions because the fee is correlated to the performance of your investments. This way, you can be sure that your advisor is trying to grow the account as fast as possible to protect both of your interests. Is this true? Well, AUM fees may ensure that your advisor is more active with your account activity (whether or not that is a good thing is up for debate). More importantly, it will not always be the cheapest option for the client, even if it does seem to line up interests. An up-front commission, especially with larger accounts that involve breakpoints, will often be cheaper than on-going fees which exit the account each year.
Ultimately, I believe that earning fees, both asset-based and flat rate, is the best way to do business. It does align client interests with advisor interests. However, I leave it at that, because to break down the conversation into finer detail is not worthwhile. One realizes after being in the business for a while that managing money is an emotional game. Clients need hand-holding, especially through rough patches in the market such as those we experienced after the tech bubble popped. Clients, at least at my firm, like to call up, stop by the office, bring in documents they don’t understand, all of this kind of stuff. The focus gradually becomes less on the fee (assuming it’s reasonable and competitive with other advisors) and onto the service aspect- specifically the trust which develops between a client and his or her advisor. This relationship between clients and respectable advisors is understated in the media and extremely important to recognize.
Ok, I feel better now that I’ve gotten all this out in the open.
Russell Bailyn
rbailyn@gmail.com