Admittedly, commission-based brokers do have a compelling story to tell prospective clients. They will “consult” with them for free, put together a financial or investment plan at no charge and they will even make a product recommendation that won’t result in any charges unless the client decides to buy. In many cases, clients won’t have to pay the adviser anything for purchasing the investment. How could that be bad?
Today’s consumers are savvy enough to know that there are no free lunches. Most people are willing to pay for what they perceive as quality advice. In fact, with their financial futures at stake, most people want to know that their adviser is being well compensated. This is why, when told that an investment product won’t cost them anything, they are quick to ask, “Well, how do you get paid?” To which a commission-based adviser might answer, “I get paid by my firm,” or “[the name of the product provider] pays me.” This is, to a great extent, very true. In fact, with most commission-based or fee-based product sales, the adviser is not paid directly by the client, but rather by a third party in the form of a commission or fee, which is the essence of a “sales transaction.”
So, the broker cannot be accused of obfuscation because it’s how the process works. The client is satisfied that the broker will receive compensation, and he is especially pleased that there is no out-of-pocket cost for the investment purchase. But that is the extent of the compensation disclosure. The client will never know how much the broker earned on the sale, nor will he know what the firm or the third-party provider earned. While the client may not feel worse off for not knowing – after all, it didn’t cost him anything – his ignorance may be costing him a great deal more than he knows. In fact, to some extent, the broker-dealer relies upon client ignorance in order to maximize its revenue.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
What the client doesn’t know about the way commission-based advisers are compensated, or how the revenue food chain works, allows the broker-dealer to mark up the price of products, or increase their share of the revenue generated by third-party fees charged against the client’s assets. Whatever the method used by the broker-dealer, the net result is a more expensive investment product for the client over the long run. To understand the revenue food chain is to understand that investments sold through broker-dealers must be able to compensate all parties in order to make it worthwhile to offer the product.
If it sounds convoluted, it is. Even the brokers often aren’t privy to the food chain compensation structure; so, the lack of transparency cuts across two layers – the client level and the adviser level. That means, in many cases, brokers couldn’t provide full disclosure to the client even if they wanted to.
The crux of the problem in commission-based sales is that the broker is not compensated directly from the client, but from the firm or a third party. Ultimately, brokers represent the source of their compensation. The only way they can represent their clients exclusively is if they are compensated directly by the client. In the end, the client cannot be assured that he is receiving unbiased advice because the broker is being compensated by the firm.
In a fee-only fiduciary relationship, the adviser is compensated directly by the client, which means the adviser is in a position to fully disclose how the fee is applied and how all parties to a transaction are compensated. That kind of transparency is a crystal-clear benefit to consumers saving for retirement.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
-
I'm an Insurance Pro: How Not to Get Dumped by Your Insurance AgentYour insurance agent or broker might show you the door if you do any of these five things. Being a good customer is about more than paying your bill on time.
-
Two Estate Planning Issues You Should Never OverlookThis estate planning attorney explains why proper asset titling and beneficiary designations make a big difference when it's time to transfer your wealth.
-
The Four D's That Could Force You to Sell Your BusinessBusiness owners (or their heirs) can be rushed into a sale of their company if they haven't planned for a major change in circumstances — or the four D's.
