Jim'sMoneyBlog

Financial Opinion and Insights

Commissions or Fees, Which is Cheaper?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You guessed it:  It depends.  Now, ten people may have ten different opinions about this issue; but, after nineteen years in this business – having begun in a Wall Street big name `wire house’ and gradually changing my business model from stockbroker to independent broker to independent planner/broker to independent planner/broker/advisor to independent planner/advisor and having spoken with hundreds of other advisors over the years at scores of industry conferences and conventions – this is my own humble opinion on this issue:

There’s no one right answer.  There’s only the one that’s best for YOU.

You have to do some analysis – and it helps if you can use a computer spreadsheet.  But, it might be worth remembering what your parents probably told you many years ago:

There is no free lunch.

If you’re thinking of using a financial advisor to get help, they – like any other professional – do charge for their services

  • Registered investment advisors (RIAs) charge fees
  • Registered representatives (stockbrokers and many independent consultants) sell investment products and earn commissions

Which is cheaper depends on how much you’re investing.  Then you have to compare what the fee advisor is charging against what the commissioned rep is selling.

Example:  Suppose you have only $50,000 and you want a growth fund.  

  • The commission approach:   It wouldn’t be uncommon or surprising to see a load of between 3-5% for this sale.  So, if the load were 4%, the rep would earn a $2,000 commission up front.  It wouldn’t be a surprise to see ongoing 12b-1 fees of 0.25% annually ($125, assuming no growth) which would compensate the rep for answering questions and servicing the account.
  • The fee option:   It’s not uncommon for advisory fees to start at 1% of assets and then go DOWN as the asset levels increase.   I think it’s fair to say few fee-only advisors would not look forward to doing all the research – and paperwork, including compliance issues – for $500 – and have to wait a full year to be paid in full.   They could charge planning fees; but how many people with $50,000 would pay the freight?  Not many I think.

 

Example #2:  Suppose you have $600,000 in your nest-egg and need help

  • The commission approach.  This can get dicey.  In the commissioned world, it wouldn’t be surprising to see `free’ planning services result in a recommendation of fully-disclosed low-cost investment products mixed with some undisclosed (hidden) high-cost products.    I know people personally who have invested as much as $1 million in a commissioned plan without knowing they’d actually paid as much as $40,000 in commissions up front – in the first 90 days – simply because many of the products looked ‘free’ to them! 

    I doubt the above experience is the `norm’ but, let’s face it:  If only 20% of your $600,000 account is placed in products with undisclosed hidden costs and paying 6% commissions, you’ve paid $7,200 in front on just 20% of your assets… that’s 1.2% of assets right there!  Even if the balance of the portfolio carried only a 1% charge, you’re still paying a total of $12,000 in the first year on your $600,000 portfolio – about 2% of assets. 

    Is all this bad?  Not necessarily.  The products may be worth it!  And, let’s face it, quality planning for that size portfolio, even with sophisticated software, still takes time simply because the investment screening requires more than simple button-pushing. 

    The point is you should KNOW what you’re paying and what you’re getting so you can make an informed decision.  It’s also important – I think – to know if the products and managers involved are proprietary (in house) or from third-parties.  What products and managers were screened-out and why?   Point:  Two identical annuity products might pay two different commissions.

 

  • The fee approach.  Generally not as dicey because of the straightforward service and fully-disclosed charges with no product sales.  But, still, RIAs differ in their charges and services.   Some will charge a one-time retainer to do your plan as well as an annual advisory fees for ongoing management oversight and portfolio consulting.   Others may not charge for the plan but will likely require a higher asset minimum to justify the time and may require that assets be placed on deposit before any work begins. 

    If there’s a planning retainer required, the amount will often depend on the complexity of the plan and the time involved.   Annual advisory fees can also vary, but it’s not uncommon to see fee schedules that start at 1% and then go down as assets increase.  For example, our annual advisory fees begin to go below 1% at the $500,000 mark.

    Each RIA sets it’s own fee schedule, but you will find that most RIAs take pride in transparency and providing full disclosure.  RIAs also use non-commission products and tend to work with stocks, bonds, no-load funds, and ETFs.  Many also like to use institutional money managers for the value they can often add coupled with the fact their charges also go down (as a percentage of assets) as portfolio value increases – something that doesn’t occur in mutual funds.

If you have questions about any of this, feel free to contact me at 800.257.6659 or 805.265.5416 – I’d be happy to help.

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The Independent Financial Group is a fee-only registered investment advisor and does not sell any financial products or receive commissions or third-pary compensation or incentives of any description.

For more information about IFG, visit our website.  

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