In the wake of Wells Fargo, Merrill Lynch and, more recently, Commonwealth Financial Network announcing that they will stop offering commission products to their IRA clients, the internet has been atwitter with comments about the unfairness of the Department of Labor’s new rules for retirement account advisors. One such posting seems to capture the general sentiment of the brokerage industry: “Let's see, fees forever or a single commission... Follow the Money! Consumer always lose.”
I have to admit, on the face of it that seems like a valid criticism. Yet, like most observations offered up these days in place of well-informed analysis (by lawmakers, regulators, journalists and political candidates), this one suffers from taking too small a view of a much larger issue: in this case, the total financial impact of conflicted advice on retail investors.
In the comment’s myopic view of only advisor compensation, there’s no denying that investors would be economically better off to pay a one-time, up-front commission of 3% rather than an ongoing annual 1% asset management fee. But of course, this analysis offers only a very limited view of investor economics, doesn’t it?
In reality, most retail investors pay for a lot more than just the services of their financial advisor. Most of today’s retail investors don’t simply buy and hold stocks and bonds. Instead their portfolios hold myriad financial ‘products’ such as mutual funds, EFTs, managed accounts, hedge funds and variable and fixed annuities.
And each of these products has separate costs—usually, a number of separate management fees, expense fees, trading costs, administrative costs, account fees, overhead costs, etc. etc. While some of these costs are, at least in theory, kept in check by competitive forces in the market place, many brokerage firms also offer their own proprietary products, which are unencumbered by competition.
What’s more, as the firm makes more on proprietary products, their brokers are often incentivized one way or another to recommend them and/or outside products offered by firms that pay extra to brokerage firms for preferential marketing over the more competitive products.
In case you missed it, the point here is that today’s retail investors bear myriad costs far in excess of either an upfront commission or an annual 1% portfolio management fee: costs that will have a far greater impact on the ultimate growth of their portfolios. Yet until the DOL passed its rule, only advisers who are paid solely through client fees—and therefore have a full-time fiduciary duty to their clients—are under a legal obligation to mitigate any of these staggering costs and fees. Brokers were under no obligation to consider investment costs in their recommendations.
Finally, let’s not forget about additional commissions paid to brokers who replace investors’ current holdings with different stocks, bonds, mutual funds, separate accounts, etc., all while earning an additional commission on each of these transactions (sales). In the old days this was considered churning, a violation of securities law. But today, with a steady stream of new and better ‘products,’ who’s to say whether one of those products isn’t ‘better ‘for the investor than their current holdings? That would make those products, therefore, well worth the additional commission.
The bottom line is that calculating the cost of financial advice by comparing only advisor compensation is like buying a car based on the lowest commission paid to the sales person. I’m sure that is exactly what the car dealers would prefer that you do.
The new DOL rules require that IRA advisors also consider the costs of investments they recommend. Broker-dealers are beginning to admit that they can’t comply under the commission model and are requiring that their brokers transition to AUM fees along with them. I’m sure it will be an uncomfortable transition for many advisors who are used to selling on commission.
But independent advisors have been making this transition to AUM fees, with compounding success, for three decades now. It’s a better business model for clients—and for advisors.
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