If you want to start a heated debate among financial advisors, ask which compensation model best serves clients: transaction-based commissions or asset-based fees? Each camp can offer arguments that support its approach: lower costs, fewer conflicts of interest, and so on.
But if you ask investors for their preferences, the response is more nuanced. According to Boston-based Cerulli Associates’ 2013 “U.S. Retail Investor Advice Relationships” report, most investors still prefer commissions. “Overall, 40 percent of investors report that they prefer to pay their advisors through a discrete fee (commission) each time they make a transaction, followed by 30 percent of investors preferring to pay asset-based fees. Interest in asset-based fees exceeds that of commissions only at the highest wealth tier (defined as greater than $5 million).”
Many advisors respond to the either-or question by working under both models. A June 2013 report prepared by Aite Group for the CFP Board, “Fiduciary Study Findings For CFP® Board,” found roughly 60 percent of registered representatives are also licensed as investment advisors subject to a fiduciary standard. Almost half of registered representatives receive compensation from assets under management or for advice. We asked several successful advisors who earn both fees and commissions how they determine which approach to use with clients.
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Tash Elwyn, president of Raymond James & Associates Private Client Group in St. Petersburg, Fla., says nearly half of the group’s revenue comes from commission-based relationships. Elwyn, who started as a financial advisor before moving into management and continues to work with a small group of clients, says that mix shows up in his book of business, as well.
Determining which approach best suits a client is “more art than science,” Elwyn says. Each client’s situation is unique and requires an assessment of the commission or fee decision within the relationship’s context. It also involves identifying an appropriate balance that’s fair to both parties relative to what he calls the “perceived value being delivered by the advisor.”
But it’s not just a question of cost because as Elwyn points out, an investor’s lowest cost option is to go it alone with a do-it-yourself approach. In other situations, the model that first appears to be optimal for the client might not be. He cites an example of a buy-and-hold investor. It’s easy to assume that a traditional commission relationship fits this client best, but that’s not always the case, he cautions. Advisors counsel on when to hold, when to trade and when it’s appropriate to reallocate and readjust portfolios, says Elwyn. Consequently, advisors can encounter buy-and-hold portfolios where both parties agree that a fee-based arrangement is equitable in light of the value of the advice being delivered.
A major criticism of the transaction model is that it creates an unavoidable conflict of interest because advisors’ income derives from clients’ transactions (apart from any residual fees). Advisors can avoid those conflicts, says Elwyn, provided they don’t ignore them. “So long as an advisor and a client are figuratively able to sit on the same side of the table in terms of trust, transparency and disclosure, those potential conflicts of interest can be mitigated and eliminated,” he says.
Allan Katz, CFP, ChFC, CLU, president of Comprehensive Wealth Management Group LLC in Staten Island, N.Y., estimates that 65 percent to 75 percent of his revenue comes from commissions. In some cases, he believes fees can be prohibitive for clients. He cites an example of a couple that wants to work with an advisor to start a 529 plan and contribute a few hundred dollars each month. A fee-based planner would have to pass that client to another advisor, says Katz, because the amounts involved are too small to make the relationship profitable. The presence of minimum account sizes or minimum annual fees can also be prohibitive for these smaller clients.
He maintains that a commission-based advisor might be willing to take on the small client, despite the modest initial compensation. The rationale: Over time, small commissions add up and automatic investment plans usually don’t require much follow-up work. Each client is different, so the advisor must be open-minded when seeking solutions, says Katz. “Look at what is the best way to solve the client’s needs,” he counsels. “If you find the best way to do it, try to make it the most cost-effective way for the client rather than think about just what’s the biggest commission for me. Sooner or later it will come back to you and you’ll wind up making more than you [would have] made by just hitting them over the head with a fee or a commission.”