Smart Women Smart Money | Harris & Harris Wealth Management

November 01, 2011

When you are buying a service, do you prefer to pay for multiple years of the relationship up front or pay as you receive the service?

Do you prefer compensation to be based on a system that you don’t quite understand or one where you know service providers are rewarded when they add value?

At the end of the day, this is the ongoing debate regarding compensation for advisory services. Which is better for the investor client? Fee-based advisory services versus commissioned-based services.

For years, financial service professionals were paid on a commission-based system driven on the premise of buying and selling individual stocks for clients. As you may remember, financial professionals were known then as stockbrokers.

The goal of a stockbroker was to get customers to either buy and/or sell shares of stocks in a particular company they recommended. The more transactions that occurred, the more money the advisor made. This was a very transactional environment. It could often lead to the unethical practice of a broker “churning” the account.

Churning is the excessive trading in a client’s account to increase commissions. (Readmore) The commission-based model, while I am not discounting as a viable option for some clients’ accounts, may not always focus the advisor on what was best for the client in the long term but on the next transaction.

In recent years, many financial professionals and the financial services industry have been transitioning to a fee-based platform. The fee-based approach is based on the advisor receiving a percentage of the assets they manage. This percentage fee ranges from 2% per year on the high side to .50% on the low side. Generally, the more assets the advisor manages the lower the client’s fee.

In this approach, as your account increased in value, the financial professional’s compensation also increased. In essence, your success was linked to the advisor’s pay. In that situation, there is incentive for your advisor to more closely manage your account.

You probably guessed that I support and use the fee-based model with my clients. I take on more risk and potentially make less money. A friend jokingly asked me “why in the world would anyone do that?”

Because I think it’s fair to the investor. I have had a chance to work for several high-profile investment firms over my career and have seen the mentality that develops in a commissioned-based system. I even felt it crept up on me. Ugh. When you are rewarded for transactions and not relationships, that’s when your emphasis can drift.

When I got into the field, it was and still is with good intentions – to do right by my clients. I am sure I am not the only one who thinks this way or thought this way upon entering this profession. But I feel that when your focus shifts from helping a client to doing a transaction to meet corporate goals and expectations, that it is only human nature to pursue the avenue that promotes the largest payouts.

The fee-based system rewards me in a way that I feel benefits my clients and helps me to sleep comfortably at night. That is by allowing me to keep in touch with you, your personal and financial goals while providing you with strategies to help increase the value of your investment. The main focus is on our relationship.

The other benefit of the fee-based system is it is more transparent. We all learned during the Wall Street debacle a few years ago that a system that is shrouded in secrecy rarely serves the investor. Investors want more and are demanding a clear understanding of the fees associated with their accounts.In the past, it was unclear, in some cases still that way, how much an investment transaction will cost. Some investors, I am sure still get their trade confirmations and/or statements and are confused as to the true cost of the investment they just purchased.

Even if they wanted to back out, there would be some costs associated with that. Nothing comes without a price. In a fee-based system, you know up front what your costs are, what you are paying for, and when the costs are incurred.

Why should you care? The difference between the two decisions could cost you tens of thousands of dollars or a lot of headache if you are trying to reach an unresponsive financial professional.

The next time you are interviewing financial advisors be sure to be clear about how they receive compensation and what incentivizes them to serve your interests.

There are times when paying up front can be considered peace of mind. Investing your life savings is rarely ever one of them.

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