Readers who have been following the fiduciary-standard-for-brokers debate since the Dodd-Frank Act became law in 2010 through to the current Department of Labor IRA proposal are going to find this very hard to believe, but I think there is one facet of brokerage commissions that has not been discussed yet (let alone beaten to death): commissions are themselves bad for commission-paid brokers.
I know, this probably sounds ridiculous to many readers, but bear with me here. And if by the end of this blog you think I’ve lost all my marbles, I’ll just have to live with that.
The basis of my thinking is the nature of the financial services industry. As with most industries, the key to understanding our industry is to follow the money. What do the most successful companies in each area of the financial industry have in common? They all manage assets. Mutual funds, ETFs and hedge funds, obviously. But you don’t have drill too deeply into the businesses of the big brokerage firms, retail banks, private banks and insurance companies to find that the vast majority of their revenues—and profits—come from managing money.
I hope I don’t really have to explain why this is the case. But just to make sure, I’ll point out that from JPMorgan Chase, to Vanguard and Fidelity, to independent RIAs, managing assets is a great business model. Unlike most industries, in which producing more revenues requires adding more people (“labor intensive,” they call it), managing assets in highly leverageable. An RIA can manage $1 billion in client AUM with just a few more people than they can manage $100 million.
Most of the employees at banks, mutual fund companies and brokerage firms are there to bring in more assets. Most insurance companies have gone one step further by spinning off their sales forces, thereby cutting employee ranks to the bone.
What’s more, asset management literally grows its own revenues by growing the assets. Even better, the assets compound. Instead of starting each year with zero sales (as do auto manufacturers or, say, Apple Inc.) financial firms already have revenues from their existing AUM: new assets are just icing on the cake. I have long suspected it’s the next best thing to having a license to print money.