The Investment Scientist

The High Cost of Fee-Based Financial Advisors

Posted on: March 17, 2012

Fee-based Financial AdvisorMany people think that fee-based financial advisors are those who charge their clients fees for service; therefore, they have more transparency and less conflict of interest. That’s exactly what the financial industry wants you to think.

Fee-based financial advisors are the financial industry’s response to the rise of independent fee-only financial advisors. Fee-only financial advisors are paid solely through fees for service paid directly by clients; they are not licensed to receive third-party commissions. Consumers rightfully associate this compensation model with integrity and unbiased advice.

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What can the financial industry do to confuse the consumer? Answer: Invent “fee-based financial advisors.” Though the name is very close to “fee-only financial advisors” and indeed they charge clients fees for advice, they also put their clients into high-commission (and high-priced) products. They make money from both sides, most of the time without the knowledge of their clients.

Take my newest client for example; he is a retired doctor. He has been using a fee-based financial advisor for many years with lackluster result. Last year, his portfolio shrunk 9%, which finally helped him make up his mind to change.

His fee-based financial advisor charged him 1.2% annual asset management fees. For that kind of money, you would think the advisor would direct investments to low cost funds? Not so. Upon close examination, I found the average expense ratio of funds in the portfolio is 1.03% and the average load is 5.1%.

For those who are not familiar with these terms, loads are a one-time charge that fund companies give to the financial advisor as a kickback. Expense ratios usually include 12b-1 fees, which are ongoing payments to the financial advisor as long as his client stays with the fund.

So this doctor was set back more than 6% in explicit and hidden costs in the first year and roughly 2% thereafter. It’s very hard to build wealth when your financial advisor is taking most of it.

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5 Responses to "The High Cost of Fee-Based Financial Advisors"

How is it possible that he was charged an annual asset management fee of 1.2% and also an upfront sales charge of 5%? I believe that its possible your assumption is wrong. Many B/D’s offer the A share fund in their fee based programs but waive the up front load. Hopefully you looked into this first prior to this writing. To my knowledge its not legit to charge an asset mgmt fee and then charge an upfront fee. Also the trend is to rebate clients the 12b-1. Some not all B/D’s do this. My thinking is what you wrote did not happen.

Great post, Michael. Thanks for spreading the word about this and in such an articulate manner. Keep it up!

John,

The upfront sales charge is front load that the mutual fund company collect for the advisor. If the advisor has a broker license, it is legit for him to collect that. It is not legit for me to collect that because I do not have a broker license, I only have an RIA license. Pure RIAs account for only 7% of all RIAs, most RIAs actually are dually registered as brokers so that can collect sales kickbacks.

I agree with John. The loads are waived and someone looking at the holdings and not realizing that would naively assume that the load were charged. I sure bet it helps lure money away from other advisers though.

Fee-based advisors (not fee only) do both types of compensation, but they are not allowed to collect a sales load upfront and charge a asset based fee. Many firms will actually exempt assets from a fee-based charge if the same advisor/firm sold the original fund.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

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