Commissioned Security Sales vs. Fee-Only Advice
To an outside observer, all financial consultants appear to be in the same business. In the sense that they are all competing for the same investment dollar, it is true. But in a more important sense, there are two distinct businesses: Commissionable Security Sales and Fee-Only Advice. For purposes of our discussion here, let’s call the commissioned salesman a retail broker, and the fee-only advisor will be referred to simply as an advisor.
A retail broker sells securities to his clients. An advisor buys securites on behalf of his clients. This is an important disctinction.
In recent years there has been a significant transfer of assets from retail brokers to advisors, especially among high net worth investors. For that reason, some retail brokers attempt to disguise themselves as advisors by calling themselves “financial planners”, “investment advisors”, and the like. Here is a good way to determine whether a financial consultant is a retail broker: If he or she has the title “Registered Representative”, then they are a retail broker. Keep in mind that some consultants wear two hats: they sell securities when wearing their retail broker hat, and they offer fee based advice when wearing their advisor hat. These consultants are called “hybrid” advisors. When working with a hybrid advisor it is critical to understand if you are paying commissions or paying for advice. Ultimately you want to know if the advice is in your best interest, or if the advice is based on what generates the biggest commission for the hybrid advisor.
In our opinion the commission based model is appropriate for certain businesses; notably those in which transactions are complex, such as real estate sales. A real estate broker is paid a commission to bring a complex transaction to a close. But securities are not complex to buy or sell. They can be traded at very low cost with one click of a mouse. It does not make sense to pay a significant amount for something that can be accomplished for very little.
However, comprehensive wealth management (including portfolio design and investment management, income tax strategies, identifying and prioritizing goals, projecting the feasibility of achieving those goals, insurance evaluation, and estate transition) is quite involved and objective advice is in high demand. For this reason we believe that the payment of an ongoing fee for advice is appropriate.
Retail brokers have conflicts of interest that we think should be avoided. They are generally compensated in lump sum commissions that leave them small motivation to give ongoing service or advice. Their judgement is often clouded because they are compensated for sales. They are generally paid more to sell expensive investments.
Advisors on the other hand do not have those conflicts. Advisory fees are generally based upon account size, giving the advisor a financial motivation that is in line with his client: both client and advisor want the account balance to grow. To that end, an advisor is motivated to purchase cost effective securities. When a client prospers, so does the advisor; when the client suffers, the advisor suffers also. Advisors are not paid when buying securities for their clients; they are paid only for their ongoing advice. This gives them a financial motivation to keep clients happy for the long term.