From the September 2008 issue of Investment Advisor • Subscribe!

September 1, 2008

The Case for Commissions

I am not an advisor and have no expertise in how clients should be serviced. But as part of an overall treatment to help advisors choose between an independent broker/dealer and an RIA model, I cannot resist, however, making some comments about product availability and also recounting some of the arguments for using commissions. Commission product uses fall into six primary categories:

- Commission-based planning for smaller clients. Proponents of this argument point out that smaller accounts are not feasible to service in a fee environment due to account minimums or the economics of the relationship. Also, the client may just need a one-time consultation rather than an ongoing one, and thus the compensation may need to reflect its one-off nature. The other side of this argument points out that hourly or project fees are available as compensation methods for such situations.

- Life-insurance. Variable life insurance is only available on commission compensation. Philosophically some advisors believe in using variable life and others do not. I would like to just point out that some fee-only advisors partner with third parties who provide the insurance services and then rebate the commission to the client.

- Variable Annuities. Variable annuities are another similar philosophical choice--some advisors use them and others consider them too expensive for the benefits offered. It is interesting that even advisors who generally do not use variable annuities report that there are clients who are very attracted to income-for-life guarantees even after the advisor tries to talk them out of the high-cost product. It's interesting to note the increasing availability of fee-based annuities on the custodial platforms.

- Real Estate and Other Alternative Investments. REITs, 1031 exchanges, oil and gas deals, and hedge fund strategies are finding their way into client portfolios and advisors have an increased interest in alternative investments. This is a very broad category and availability definitely is a factor differentiating broker/dealers and fee-only platforms. The availability of alternative investments on the custodians' platforms is increasing but not complete. Hedge fund strategies are probably neutral territory with custodians having access to as many if not more hedge managers. Real estate and other deals, however, continue to be primarily broker/dealer territory.

- Trials. Many practices that exist today were started in the 1980s and 90s with commissionable product lines and many practices still have a significant amount of trail commissions. The trail revenue in some practices is too large to simply be forfeited and many of the hybrid practices that exist today have chosen the hybrid model primarily because they are looking to continue the trail revenue. As a rule of thumb, any trail revenue that is less than $50,000 is probably not significant enough to offset the additional cost of maintaining compliance with two regulators and navigating different technologies. This implies that the trails are the only reason for staying registered with FINRA. Custodians also have significant expertise in helping advisors convert between share classes.

- Product compatibility outside of compensation. Occasionally, some assets are not compatible and cannot be held in a custodial account. In those situations the advisor has no choice but to either maintain registration or leave the assets behind. Depending on what's best for the client, there are also trading tools such as Metamorphosis that create a tax-efficient transition if the assets need to be liquidated in order to be moved.

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