The Fee-Based Trend

Fee-based advisors come in different forms

Traditionally, financial advisors were compensated via commissions from products they recommended and sold to their clients. In fact, this probably remains the most prominent method of advisor compensation in the industry today. Lawyers and accountants have traditionally been paid based on their time or on a fee-for-service basis. While there are some financial advisors that work on this basis, they are a tiny minority. There is a huge trend sweeping through the financial advisory business. The trend is seeing advisors getting away from earning commissions from selling products to earning an on-going fee as a percentage of your total assets – regardless of the products used. There are definite benefits to this approach but there are potential dangers as well.

Traditional compensation – brokers vs. planners

Stockbrokers have historically been more transaction-driven (as has their compensation) as compared to their financial planning counterparts. (A stockbroker is a financial advisor working with a stock brokerage firm, selling mainly stocks and bonds. By financial planner, I’m referring mainly to advisors licensed with mutual fund dealers and insurance firms.) For years, brokers earned commissions only when they recommended a ‘buy’ or ‘sell’ to their clients. While their clients were in the ‘hold’ position, they made no money. In fact, that remains true today for those brokers still opting to recommend specific stocks and bonds to their clients.

Financial planners, on the other hand, have traditionally earned a large up front commission when selling a product (be it insurance or mutual funds), then earning an annual bonus (insurance) or quarterly trailer fee (mutual funds). While bonuses and trailers differ, conceptually, they both represent a fee paid by the insurer or mutual fund company, respectively, to the advisor for providing on-going service while the client continues to hold the respective insurance policy or mutual fund. The large commission up front usually makes sense since a financial plan typically entails a lot of work up front to gather data and get things set up.

However, things are changing.

The new fee-based approach – brokers vs. planners

In both cases, the trend is moving away from larger up front commissions, to higher on-going fees. The products and/or services used to generate this new income stream differ depending on the type of advisor with which you currently work.

I can’t believe the number of stockbrokers who have told me “I no longer recommend any individual stocks – it’s too hard”. So what are they doing? Brokerage firms have forged relationships with the world’s best-known money management firms so that brokerage clients can get professional management but still buy stocks directly. These are known as individually managed accounts (IMAs). IMAs charge an annual fee as a percentage of your portfolio value and provide a specified number of free trades per year, plus a bunch up front to get the portfolio set up. Fees aren’t necessarily cheaper but are more ‘visible’ since it’s invoiced directly to investors. This new trend toward IMAs will definitely make life easier for stockbrokers because they will earn a steadier and higher income over time. However, that doesn’t necessarily mean investors will be worse off. Just think about it, this means the ‘churn-and-burn’ broker is becoming a thing of the past – something investors and brokerage firms should be happy about. However, it’s always important to judge what you’re paying in the context of the services you will get in return and what is available from other firms and advisors.

Financial planners are riding this trend a bit differently. Since most planners aren’t licensed to sell stocks, they don’t have access to the broker-sold IMAs. Instead, planners are focussing on pooled wrap programs like AGF Harmony, CI Insight, Dynamic Viscount, and other similar proprietary wrap programs. My opinion on pooled wrap programs has been well documented (http://www2.myto.com/money/tidd_fs.cfm?source_id=&id=687993) in this space and it’s not good. That said, as long as the fees are reasonable and the advisor provides good value for what’s being charged to the client, the pooled wrap can be a good deal. Again, compare what you pay with what you get, and with how competitive that is in the marketplace.

Don’t be too quick to form an opinion just yet. I’ve only told you half of the story. We’ve yet to discuss the potential conflicts and other advantages and disadvantages.

Next week: the pros and cons of fee-based advisors and how to spot a traditional commission sales pitch dressed up like the hot new fee-based trend.

Dan Hallett, B.Comm., CFP is Senior Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a mutual fund dealer in Ontario, British Columbia, and Manitoba.