There is a lot of confusion about the compensation of financial advisors. Should they be compensated with fees or commissions? How much are they paid? What services do investors receive for the money they pay them? Should advisors provide written disclosure for their compensation?
The confusion is no accident. It exists because Wall Street wants it to exist. This is because the financial services industry has a core conflict in its business model that damages investors. Confusion helps mask the magnitude and impact of the conflict.
- Wall Street's business culture is based on sales. The star advisors are big "producers" who generate large amounts of commissions.
- However, investors do not want sales reps investing assets they will use for retirement and their future financial security
This investor need creates a major marketing problem for Wall Street firms and advisors. Its culture is not consistent with the needs of its clients. The industry solution is not to change its basic sales culture - it makes too much money. The Wall Street solution is to blur the distinctions between fee advisors and commission representatives by using deceptive sales tactics:
- Reps tell investors a one-time commission is cheaper than an annual fee
- What they don't say is it takes fives years for a 1% fee to equal a 5% commission
- They say their role is to help investors achieve their financial goals
- Based on compensation, their role is to sell
- They say they have the same role as financial advisors
- Representative licensing limits them to selling products
- They are not allowed to provide advice or provide continuing services like real advisors
- They say their recommendations are free because they are paid by third parties
- What they don't say is third parties (mutual fund families) mark-up their fees to investors to recover the commissions they pay sales representatives
Notwithstanding Wall Street's culture, investors need advice and services that help them achieve their financial goals. The appropriate way to pay for advisor knowledge and services is with a fee for seven reasons:
- Other professionals, such as lawyers and CPAs, are paid fees for their knowledge
- Fee advisors have agreements that describe their compensation and services
- Advisors, who are compensated with fees, have fewer conflicts of interest
- Investors pay for fee-advisors' services as they receive them
- If fee advisors do not meet expectations they are terminated and their compensation stops
- Fee advisors provide ongoing financial services
- When advisors are paid asset-based fees, the way they make more money is to grow investor assets
