Deciding Whether To Pay Fees or Commissions
By Anthony Rhodes
On previous posts, I’ve explained to you some of the better ways to select a financial advisor. We’ve gone over screening protocols, appropriate questions to pose and expectations one should hope to receive, but I’ve stopped short at advising on which payment model one should accept. One of the reasons why I’ve done so is because of the very personalized nature of each model: some investors choose to pay a commission on each transaction they make, and others, to pay an annualized fee, based on the entire value of their portfolios. Now, each of these models has their proponents and detractors, but there are some data that investors ought to be familiar with, which I think separates one from the other. Under full disclosure, I’ve chosen to be paid on the fee model (for reasons I will later explain), but the decision as to which one is appropriate for you, must ultimately come down to your own personal set of decision making criteria.
While the titles of broker, advisor, manager or consultant all fall under the same nomenclature, most investors have no idea as to which one is associated with which payment model. And though one should make sure that their investment professional has the appropriate licenses needed to purchase various securities on their behalf (Series 7and Series 65), they should also understand how such a person is compensated. So this week, we’re going to perform a benefits analysis on both of these choices, with the ultimate goal being to give you the information necessary to make a more informed payment decision.
By Any Other Name...
In a perfect world, it really wouldn’t matter which choice to select; as every financial advisor would be honest, and all would act in a fiduciary capacity. Whether you’re paying fees or commissions would be of little consequence, because both payment methods would be used in service of the best interests of all clients. Unfortunately, this is not the case, and for this reason, investors need to study the differences between commissions and fees. A “commission” is paid to a broker who buys and sells securities for another. If you’re paying someone to simply perform this act, that is what this person is (regardless of their other numerous titles). For those of you who like to purchase securities based on the recommendations of a firms’ research department, this may be the choice for you. But in my opinion, the problem with a broker is that he or she has no vested interest in the growth of a clients’ assets; because their payment is based on each transaction, and not the overall value of the portfolio. One would assume that the broker’s suggestion of purchase would be based on the client’s best interest (and in many cases they are), but there’s no inherent mechanism to ensure this to be the case. In addition, brokers work for brokerage firms, and some of their revenue is based on the repeated generation of these transactions. This should be understood and recognized before you make your decision. On the other hand, “fees” are paid to managers who oversee the performance of a clients’ investments. Their compensation is based on the overall value of each clients’ portfolio. Under this arrangement, when the client loses money, so does the manager; which implies an inherent benefit to ensure portfolio growth. Now, in recent years, the name “brokerage” has all but been eliminated by the historic firms which made it famous, with wealth management, capital management or asset management being its replacement. This new description makes it difficult to ascertain which model each company supports, and therefore produces ambiguity. However, while the name “brokerage firm” is becoming antiquated, and rarely used by such companies, most, if not all, still offer “brokerage services”, so learning how to differentiate one payment model from the other becomes even more important.
The title of “Financial Advisor” encompasses a wide variety of descriptions; with broker, manager, consultant and others all falling under its purview. It implies that each of these various sub-titles are performing the same valuable service of providing financial advice to the investing public. However, the term “advice” is very subjective, and means different things to different people. So getting to the root of how each of these designations are actually compensated, reveals the truth of their meaning of the word.
(Anthony Rhodes is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective www.theplanningperspective.com )