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Commissions vs. fees: What’s best for clients?

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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.

View from the top

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.

Business development

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.”

There’s another reason for taking on smaller clients and keeping their costs down, in Katz’s experience. He’s found that every account, no matter how small, can lead to relationships with much larger clients. “The other part of that equation is that you don’t know who that person knows,” he says. “There’s no saying that they don’t have a rich uncle or grandfather or father, somebody who has a lot of money … who might one day say, ‘Hey, you know, I’m not real thrilled with my person anymore.’ Then that person says, ‘This guy took care of me even though it wasn’t a big account. He did the right things by me. Why don’t you give him a try and see what happens?’”

Staying aligned

Brian Orol, CFP, president of Strategic Wealth Management in Raleigh, N.C., provides full-service financial planning. In addition to operating a registered investment adviser (RIA) firm, he has his Series 7 license with Raymond James. Unlike many advisory firms that work primarily with mutual funds and exchange-traded funds, Orol’s firm prefers individual stocks and individual fixed income over mutual funds. “We will use mutual funds, but very sparingly,” he says.

Most of his work with clients is fee-based, but he’s found instances when that model doesn’t fit. He cites clients with buy-and-hold municipal bond positions as examples. Those assets are better suited to hold outside fee-based accounts due to their lack of trading activity, he says. Transaction-based accounts with discounted commissions can also work better for smaller entry-level accounts. It’s a question of the value proposition, says Orol. “We want to align how our clients are being billed with what we’re delivering.”

Clients do occasionally raise the compensation issue, according to Orol. When that happens, he and the clients review the account’s costs and the services that Orol delivers. They then compare the results for a fee-based or commission relationship. It’s a transparent process, he says, and ultimately, clients control how they wish to pay.

The comparison also allows Orol to highlight the additional services and value his firm delivers to fee-based clients. “There are other things that we bring to the table, which, of course, are all included in a fee-based model and are not charged (to the client),” he notes. “We don’t charge clients extra and when we do deep-dive financial planning, , that is all included if they’re in the fee-based model.” 

Awaiting the Regulators

These advisors believe that the ability to charge either commissions or fees gives them additional flexibility and benefits clients. That flexibility may be constrained in the future, however, depending on pending U.S. Securities and Exchange Commission (SEC) and U.S. Department of Labor (DOL) decisions on whether brokers should be required to act as fiduciaries. The SEC chairman recently reported that the Commission would issue its decision by year-end; the DOL’s proposal is expected by late summer. 

It’s an important distinction. Assuming a fiduciary duty means advisors must meet the “best interest” standard with clients. Brokers are generally held to a suitability standard, which allows judgment on whether an investment recommendation is appropriate for the client’s circumstances.

Proponents of fiduciary status believe it will enhance investor protection. Opponents argue that it will not necessarily help investors, but it will certainly increase brokers’ liability and add to their compliance. The National Association of Insurance and Financial Advisors surveyed its members about the fiduciary question in late 2010. Their responses indicated that requiring fiduciary status could diminish smaller investors’ access to financial advisors. Sixty-five percent of the respondents said that if the fiduciary standard increased their compliance costs by 15 percent or more, they would need to take action that could limit access to their financial advice. These actions could include working only with affluent clients, not offering securities, and increasing fees.

At this point, it’s speculative to forecast what changes the agencies might propose and how any changes might affect advisors’ use of the compensation models. However, according to an April 13, 2014 Wall Street Journal article , the DOL, at least, might try to find a middle ground. The paper reported that the department is “working on a package of exemptions that would permit advisors to receive many of the forms of compensation they now receive, while also offering protections to make sure conflicts of interest don’t bias the advice they offer.”


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