From the August 2011 issue of Investment Advisor • Subscribe!

The Perils of Financial Geography

As an industry, we are blessed with an abundance of creative home office types who cleverly apply mathematics to convince even sophisticated advisors that they have somehow managed to squeeze more than 100 cents out of a dollar. In reality, they are engaging in a game of financial geography, allocating the same dollar across various regions of the relationship.

In our business, 100% of the money in motion comes from the client. There is no other source of funds. Moving revenue and expenses from client to advisor to broker-dealer is financial geography. Regardless of where the expense resides, it is the client’s dollar.

Commissions and payouts, technology, incentive trips, 12b-1 fees, office space and related expenses at wirehouses, bonuses, etc., all come, directly or indirectly, from your clients. So, to the extent that a firm is able to offer an up-front bounty (aka bribe) to an advisor to join them, where does that money come from? Yes, even that six- or seven-figure upfront bonus or loan comes from the advisor‘s clients’ returns.

The vast majority of broker-dealers have developed financial affiliation models (payout schedules) based on simply rearranging the same dollar of revenue. Some, like wirehouses, are basically retail outlets for the products they generate and sell. Others are retail outlets for other businesses in that they offer little in terms of value beyond marking up or private labeling services offered through and supported by the clearing firm or custodian.

Perhaps the question advisors should be asking prospective BD firms is not “how much will you give me up front?” but “how much does it cost my client—and me—to do business with you?” To fairly assess the true value of each element in the financial services supply chain (BD, clearing firm, custodian, manager, etc.), start with the total amount the client pays for the privilege of accessing your services. This includes your fee, manager fees, platform fees, ticket charges, etc. What portion of that total fee accrues to you, the advisor? What portion of that total fee goes somewhere else in the supply chain?

Naturally, there are justifiable expenses that any broker-dealer has, and the profit margins on the business are thin. However, are those expenses—and the subsequent costs to the advisor and ultimately the advisor’s clients—being handled in a transparent and equitable manner?

When a firm offers a large upfront bonus, how much more do the advisor’s and firm’s clients pay in expenses—obvious and hidden—because of this? How does this improve the outcome for the client?

Today, too few firms work to reduce or eliminate the overall costs for the end client.

The purpose of each component of the supply chain between client and solution should be to add value. Sadly, a high percentage of firms crowding the supply chain are failing to do this, raising a credibility question about the purpose of their existence.

Advisors need to consider if they are impacted by this overdue disintermediation. They need to determine what services they need or use (outside of regulatory fiat) from their current broker-dealer. Which of those services are actually performed by the BD and which are performed by the clearing firm? How many times and how much are they being marked up? How many times is your client paying for the same service?

The role of an advisor’s industry partners should be leverage—helping the advisor benefit from scale and also expense reduction for the advisor and the client. Regardless of where a firm finds itself in terms of the financial advisor supply chain, any time it can find a way to reduce operating expenses for the advisor, value is added and the client benefits.

Don’t be misled by financial geography. It’s all the same dollar—the client’s. Advisors and their clients deserve transparency about costs and cost management, not mathematical sleight of hand.

Matt Lynch
President, CEO
Capital Analysts

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