I was shocked at when I came across the following Bloomberg news article titled, “Investors Prefer Commissions to Account Fees.” Here are the main points:
- 47% of investors prefer commission-based accounts
- 27% of investors prefer assets under management fees
- 26% of investors prefer either retainers or hourly rates
The article does not clearly define what commissions the survey is referring to. There are two options: broker-dealer commissions (i.e. loads on mutual funds) or brokerage house commissions (e.g. commissions on stock transactions made at discount brokerages). However, when you are interacting with a financial adviser, she generally gets paid more than $8.95. With the assumption that the investors surveyed are referring to mutual fund loads, this suggests that there is a deep misunderstanding of value–assuming all else equal.
For the past decade the trend has moved away from commission-based advice and toward asset-based fees. In 2010, 66% of financial advice was primarily paid by asset-based fees; compare that with 46% in 2003. From the perspective of a registered investment adviser with a fiduciary responsibility, I advocate strongly for asset-based fees. They align interests. As a side note, if every financial adviser had a fiduciary responsibility I might be able to make an argument that a commission basis is appropriate. But this also requires every adviser to have a strong moral ethic.
The investors that prefer not to pay an ongoing fee do not perceive the value. Unfortunately, they equate value with return; and the last 10 years of flat performance for domestic equity markets has reinforced this perception. As we transition to a tactical investment management era, commissions will be harder and harder to justify. Commissions create a barrier that needs to be overcome in order to break even. While asset-based fees also create a barrier, the barrier is much smaller and the tradeoff is flexibility. Furthermore, I believe most services that are purchased upfront (e.g. commissions or hourly) disincentivize a continued healthy relationship. An asset-based fee requires, theoretically, continued satisfaction; whereas, a commission requires the opposite.
I have deviated from the point I wanted to make. However, it is hard to make the point without first justifying asset-based fees. In my opinion it is clear that asset-based fees are in the client’s best interests. The fact that investors do not agree suggests to me three things:
- There is a great distrust toward representatives of the financial industry
- Clients feel they do not receive enough value from their asset management service
- Change is a very slow process
Based on the study, the most typical client is dissatisfied and thinks their broker dealer has a fiduciary responsibility, yet doesn’t know how they pay for advice but would prefer a commission-based account. The study didn’t actually state that, I’m just pulling together the highest percentages. There are many dynamics at play within the investment management industry and they all factor into account performance. Let me suggest several examples of other industries and you can decide for yourself: car salesman, realtor, wireless service provider, cable provider, restaurants.