Without question, one of the most difficult things to understand for most investors concerns the compensation received for servicing an investor's account. "What are the fees?" "How do you get paid?" Those are two of the questions that this financial advisor is asked, most generally in, every "get to know you" meeting. If you're a prudent investor, your diligence is required understanding not only the fee or commission but what you're paying for and how that compares to the industry average. Let's unpack this sensitive issue and look at the pillars supporting your portfolio.
Investing money should have a purpose. Goals are not accomplished merely by happenstance. If you're intentional about the purpose of your money, that's a great start. Give yourself an opportunity to sit with an advisor and explain, as clearly as possible, what your intentions are with this particular asset. Be specific. Be intentional. (For more, see: Choosing an Advisor: Suitability or Fiduciary Standard.)
Your advisor should be someone you trust more than anything. It helps to like them as well. Your advisor should be qualified to help you with your goals. If they aren't properly licensed and registered, you should be moving on. Nothing says "charlatan" more than an unregistered, unqualified professional soliciting control of your financial assets. Always check your investment professional on brokercheck.finra.org. If your "financial" advisor isn't found here, you might be dealing with a poseur. Advisors can be licensed in many ways but the most common are the following: Series 7, Series 6, Series 63, Series 65 and Series 66. Each of these licenses allows an advisor to collect fee for service or commission. Which is which? (For more, see: A Guide to Choosing the Best Robo-Advisor.)
Series 7 – General securities license that allows an advisor to transact the sale of registered securities ranging from individual equities, bonds, government issued securities, direct participation programs and investment companies. These transactions pay a commission, usually anywhere from 1.5% to 10% for some direct participation programs.
Series 6 – Allows an advisor to transact investment companies and variable contracts or mutual funds, unit investment trusts and variable annuities. These transactions pay a commission, usually anywhere from 1.5% to 5.75%.
Series 63 – Uniform Securities Law exam designed to test the candidates general knowledge of state securities laws. This license is held in combination with the Series 6 and Series 7.
Series 65 – Uniform Investment Advisor Representative Law exam designed to test the candidates knowledge of laws associated and pertaining to those individuals charging a fee for service.
Series 66 – Uniform Combined State Securities Law exam. This exam combines the Series 63 and 65. Allows an advisor to charge a fee for service.
Fee for Advice vs. Commissions
It's no surprise that financial advisors do not provide a free service. How they collect compensation is, in my opinion, complex. Before we break out how advisors are compensated investors need to understand that broker dealers transact securities for a commission and registered investment advisors or, more commonly RIAs, charge a fee for service. RIA is often misinterpreted to be an individual but it is the organization itself. Registered reps work for a broker dealer and investment advisor representatives work for RIA's. Confused? Good, let's continue. (For more, see: Fee-Only Financial Advisors: What You Need to Know.)
Investments vehicles come in all shapes, sizes and each comes with a related expense that the issuing company or sponsor has designated based on a fair determination of marketability and potential return. Conservative investments usually have slightly lower fees so the investor may receive their equitable share of the potential return. Without laying out a menu of investments and the average corresponding expense, let's just say that most investments are available for your portfolio though a commissioned transaction or fee for service account. (For more, see: Paying Your Investment Advisor - Fees or Commissions?)
Commissions come out of your principal. They can be "front load" or a "contingent deferred sales charge" and come out later. An investment can also have a combination of the two. A commission is divided up among the interested parties. The sponsor of the investment receives a share. The broker dealer and also the advisor receive a share. It's normal for the advisor to receive at least 25% of the commission and as high as 90% (90% would be far less common). Of course, advisors can be both employees and private contractors. Employees would likely receive the lower end of the commission range and the higher end would go to the private contractor. This percentage would be gross and not net considering corresponding expenses and ordinary income tax. Example: The investor purchased an investment for $100,000 with a front load commission of 5.75%, or $5,750. The investor is effectively putting $94,250 to work for their account. (This is a hypothetical example only and does not represent any particular investment.
The opinions voiced in this material are meant for general information only and are not intended to provide specific investment advice or recommendations for any individual.)
Fees are charged for advice on an investment/s and also service provided. Fees are likely to be annual and assessed once per quarter. The average range of a fee based account is 1%-2.5%. For a fee of 1.5% charged quarterly, an investor would realize a 0.38% change in each quarter on the average account balance for that quarter. Example: The investment advisor representative is managing an account of various investments for a client and charging an annual fee of 1.85%. The average account balance for each quarter of the year was exactly $100,000. The client paid the fee quarterly, totaling $1,850 for the year. Fees can also be charged for services related to your investments such as planning, use of client related software, advice on an outside account like a current work plan. (This is a hypothetical example only and does not represent any particular investment. The opinions voiced in this material are meant for general information only and are not intended to provide specific investment advice or recommendations for any individual).
Which is Best for Me?
Often the question will be, "Which is best?" Each has its upside. Upfront commissions usually mean lower ongoing expenses. Over time, this options is less costly to the investor but it means you've decided you're in for the long term with this one investment. Being charged annually is less costly in the beginning but over time costs more than most front load shares of the same investment. However, this options gives greater flexibility to change investments rather easily without being charged a commission. I was asked the question regarding a multi-million dollar account from a competing firm if the annual fee "was good" (competitive). Based on the account size, I'd say the advisor is pricing only on cost and not necessarily providing a value added service for the fee being collected. That's a great way to lose any millionaire client is not provide a service for the fee being charged. If you're being charged an annual fee, you need to be getting something more than just a portfolio of investments.
You're paying for something tangible from a service perspective – know what that difference is. (For more, see: Financial Planning: Can You Do it Yourself?)
The Bottom Line
So which is best? It really doesn't matter so long as the investor is aware of each charge and how if impacts their portfolio. If you think you're paying too much contact your advisor and have them detail the expenses for you. If you're still not satisfied, contacting another advisor may be the only way to determine if you're getting what you're paying for. (For more, see: Advice for Finding the Best Advisor.)
This material are for general information only and not intended to provide specific advice or recommendations for any individual. Clients should consider whether it would be better to pay separately for each trade executed and each product and service used. Since these factors may change, clients and advisors should periodically re-evaluate whether the ongoing use of an asset-based fee program continues to be appropriate in servicing client needs.