The fee-based brokerage account has frequently been a target for investigations in the financial services industry. In 1995, the Securities & Exchange Commission released a statement to the effect that fee-based accounts served to better align the interests of the financial advisor with the interests of investors. Since that time, it has become clear that no eveyrone agrees. Read on for the pros and cons of a fee-based brokerage account.

The Root of the Issue
Historically, commission-based brokerage accounts were (and continue to be) criticized because brokerage firms earn commissions when investors make trades. This no-trade-no-fee approach provides a powerful incentive for brokers to get investors to trade, which encourages boiler room tactics. The fee-based brokerage account, once hailed as the antidote to this problem, has come under fire because, according to regulators, some clients in these accounts are not trading enough. (To learn more about fee-based investing, read Introduction To Fee-Based Brokerage Accounts and Wrap it Up: The Vocabulary And Benefits of Managed Money.) Regulators point to the low level of account activity and say that some investors are paying higher fees than they would pay in traditional commission-based accounts.


From a regulatory standpoint, a complicated series of definitions, legalities and regulations can be summarized by sorting investments into two categories: advisory products and non-advisory products. With advisory products, the advice provided by financial services professionals is considered to be a material part of the process. Investors are essentially paying for advice and getting commission-free trades as part of the package. With non-advisory products, the regulators view the advice as incidental.

These fairly straightforward concepts become problematic when applied to the fee-based brokerage account. While it is classified as a non-advisory product, in practice many advisors include ongoing advice as part of the package of services they provide to their fee-based brokerage account clients. This approach lets investors make an unlimited number of trades without paying commissions or worrying about the motivation behind their advisor's recommendations.

However, according to the regulators, investors in fee-based brokerage accounts are paying for trading, not advice. From a regulatory standpoint, products that do not come coupled with advice receive less scrutiny. Less regulation would seem like a good thing from an investment advisor's point of view, but it doesn't quite work out that way in practice. With regulators viewing commission-free trading as the primary component of the product, and advice as a minor issue for which advisors are not being paid, advisors no longer have any incentive to invest the time and effort required to help clients explore their financial needs, create an appropriate asset allocation strategy, design a portfolio, or provide ongoing oversight. As a result, most investors may be better off putting their assets into a discount brokerage account and paying for each trade as it is made - often at a cost of less than $10 per trade, versus up to 1% of assets in a fee-based brokerage account.


Under this new interpretation of the rules, the only way for advisors to get paid and stay out of trouble with regulators is to encourage the investors to trade. Of course, encouraging investors to trade raises the specter of potential conflicts of interest - the exact issue that fee-based accounts were invented to help advisors avoid. Thinking about it from an economic perspective, the regulators' goal of ensuring that investors pay less under a fee-based system than under a commission-based system seems reasonable for investors, but what about from an advisor's point of view? This situation transforms the advisor's role. Instead of seeking to provide the best possible advice, the advisor becomes a salesperson.

Conclusion - Your Portfolio
Regulatory issues aside, does a fee-based brokerage account have a place in your portfolio? The disconnect between the regulatory stance and actual practice makes this a difficult question to address. At the moment, the answer largely depends on your perspective, your objectives and the quality of the advice you are receiving from your financial services professional.


If you trade frequently and appreciate a few tips from your advisor, both you and the regulators may be happy with the status quo. If you want unbiased advice, comprehensive financial planning services and commission-free trading, the situation is a bit more complex. Despite the fact that regulators discount its value, many advisors do help their fee-based brokerage clients create comprehensive financial plans with ongoing advice and portfolio monitoring. If you can find such an advisor, or if the industry officially creates an advisory version of the fee-based brokerage account, the fee-based brokerage may still work for you. If you don't want advice and don't trade frequently, working with a financial advisor and putting your money in a fee-based account may not be the right approach.



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