Back in the early 1990s, when I was an editor at Worth magazine, I used to give a speech to groups of our readers about the common mistakes made by retail investors. One of those mistakes was, and still is, failing to take investment or advisory fees seriously because they’re usually represented as a small percentage or even a fraction of a percent.
Most people don’t realize that the difference between the 80 bps a financial planner might charge and 2.60% in a brokerage account can have a dramatic impact on one’s investment account over 20 or 30 years. I don’t think it’s a stretch to say that many a fortune has been created upon this ignorance.
I was reminded of that speech as I was reading yet another article about the newly “discovered” discrepancy between the CFP Board of Standards’ and NAPFA’s definitions of “fee-only.” As you may remember, one of the surprising revelations to come out of the Board’s reprimand and forced resignation of its own former chairman Alan Goldfarb (see Melanie Waddell’s original news article on the Goldfarb case, my previous blog on Goldfarb, and see Michael Kitces blog post on the subject), was that the Board’s standard is “higher” than NAPFAs. Specifically, while the Board restricts a CFP from calling his or herself “fee only” from any ownership in business that charges commissions, NAPFA allows its members to own up to 2% of a broker-dealer. Mr. Goldfarb ran afoul for owning a 1% stake in a BD.
While researching the Goldfarb case, I was as surprised to learn of historically rigid NAPFA’s leniency over BD ownership as was Goldfarb over the Board’s rigidity. Now, on August 20, Ann Marsh in FinancialPlanning.com quoted NAPFA’s new CEO Geoffrey Brown as saying “We look at 2% as a very insubstantial stake,” that he believed “would affect no more than 5% of NAPFA’s 2,500-strong membership.”
I really don’t mean to pick on the new guy here, but I’m assuaging my conscience with the assumption that Mr. Brown was coached on his remarks by more seasoned NAPFA board members. But it seemed like a most curious thing to say, about a most curious membership standard. For one thing, 5% of 2,500 is 125 advisors, not necessarily an “insubstantial” number on its face. If it turned out, for instance, that 125 members were charging their clients commissions, I doubt very much if NAFPA’s board would find the number ‘insubstantial.’
But even more curious is that NAPFA would set the standard as a percentage, and then defensively claim that the percentage itself represented an ‘insubstantial stake.’ What industry do these guys work in? Is it just me, or does this sound very much like retail investors writing off ‘loads’ because they are ‘insubstantial’ percentages?
To get a handle on just how ‘insubstantial’ a 2% stake in a broker-dealer is, I logged onto to Yahoo Finance and searched the market caps of a few brokerage firms to create the table below. As you can see, with a market cap of $49.8 billion, a 2% stake in Morgan Stanley would be worth $996 million. Closer to home, 2% of Charles Schwab Corp would go for $534 million, 2% of Ameriprise is worth $320 million and a similar stake in AIG would fetch $1.4 billion.
Granted, the chances of a NAPFA member negotiating a 2% stake in Schwab is probably pretty low. But how about a $5 billion AUM “fee-only” firm cutting a deal for a 0.2% share (worth $453.4 million) or a 0.002% stake (worth $45.3 million) in Schwab? Or a 0.02% share of ING (worth $84 million)?
Could this ever happen? Who knows what kind of a deal a BD might offer a large RIA to get a toehold into that growing market? In any event, I doubt that many would argue either that these are ‘insubstantial’ stakes, or that they don’t represent substantial financial conflicts of interest that could, under some circumstances, influence an advisor’s judgment.
I’m just humbly suggesting that perhaps when it comes to assessing conflicts, NAPFA might want to take a page out of the retail investors’ handbook, and shift its focus from percentages to the actual dollars involved.