A Fee By Any Other Name…

on March 13, 2017

take a lookis still a fee. A common area of confusion for clients is exactly how financial professionals get paid. Sometimes, it can even look as though the adviser is working for free. However, let me promise you that they aren’t. Today, I’d like to explain some of the more common ways financial advisers are compensated.

Commissions

Commissions are probably the most common way that financial professionals are paid. When you purchase an investment that charges a commission, you pay the adviser a percentage of the value of the investment, usually that day. If you are investing $10,000, and the commission is 5%, then the adviser would earn $500.

The problem with advisers isn’t that they earn commission; it’s that the commission is so well hidden. If you purchase a mutual fund, the price of the commission is buried into the value of the price of the share. And the different ways you can pay the commission lead to the creation of different “share classes” of exactly the same investment product. As a result, a mutual fund company could issue shares that include the price of commission in the purchase price. Additionally, they could include the price of commission in the redemption price (the price you get when the shares sell). Sometimes, they pay the adviser through a higher annual expense ratio, an annual amount you pay to hold the fund. Funds for your company’s retirement plan may have yet another fee structure.

You can see the confusion for yourself if you go to a site like www.morningstar.com, and you type in the name of the fund rather than the ticker symbol. You will have an array of possible symbols that all apply the fund name you entered. They all have slightly different expenses associated with them. If your brokerage firm doesn’t include the symbol on your statement, trying to figure out how much you pay can be almost impossible.

Fees

Fees are straightforward to calculate. If an adviser only charges fees, it’s easy to see what you pay. Usually the fee takes one of three forms: a percentage of assets under management, an hourly fee, or a retainer. The confusion arises if the adviser charges fees and commissions. It’s important for you to understand what products are being charged by a fee, and what is generating a commission.

Trails

Trails are extra money, after the commission, that the adviser earns each year you hold an investment. It is likely a part of the annual expense ratio of the fund, and it’s part of the commission model.

Payment from the Firm

Sometimes an adviser will lead you to believe that you aren’t paying him or her for the investment. Although technically true, it’s a little misleading. Now, some advisers are actually paid a straight salary, but many are paid from the company that created the product you just bought. Annuity sales often take this form, and the amount of money paid to the adviser is frequently a percentage of the money you invested. Your surrender fees help ensure the company won’t really lose any money by paying the adviser.

Soft Dollar Payment

Sometimes, your adviser can obtain something of value other than money by selling you a product. The Department of Labor’s Conflict of Interest Rule (aka the Fiduciary Rule) did a good job exposing contests and promotions that entice a financial adviser to choose a specific product for you. Extra services also can be offered to financial professionals to encourage them to make certain investment decisions on your behalf.

Bottom Line

Everyone gets paid. No one works for free. What matters is that you understand the total compensation that your adviser receives for any recommendation. Ask them. With a possible repeal of Dodd/Frank and a delay in the implementation of the Conflict of Interest Rule, you need to be your own advocate.

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