Why Commission-Based Compensation Can't be Transparent
The cost of investing through a broker-dealer may not be what you think it is. Believe it or not, your broker might not know the full cost structure, either.
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.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
Woodring is founding partner of San Francisco Bay area Cypress Partners, a fee-only wealth consulting practice that provides personalized, comprehensive services that help retirees and busy professionals to enjoy life free of financial concern.
-
Is a Phased Retirement Right for You?
Want to keep working, just not as hard? A phased retirement may just be the answer.
By Kimberly Lankford Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
Pros and Cons of Waiting Until 70 to Claim Social Security
Waiting until 70 to file for Social Security benefits comes with a higher check, but there could be financial consequences to consider for you and your family.
By Patrick M. Simasko, J.D. Published
-
Now Could Be Time for Private Investors to Make Their Mark
The venture capital crunch may be easing, but it isn't over yet. That means there could be direct investment opportunities for private deal investors.
By Thomas Ruggie, ChFC®, CFP® Published
-
How to Stop Boredom From Ruining Your Happy Retirement
Retirees who explore new interests and have an active social life are more likely to find joy — and even greatness — in the newfound freedom of retirement.
By Richard P. Himmer, PhD Published
-
The Life-or-Death Answers We Owe Our Loved Ones
How our life ends isn’t always up to us, but that question too often must be answered by loved ones and health care workers who don’t know what we would want.
By Joel Theisen, RN Published
-
Hot Tips for Home Buyers and Sellers Right Now
Real estate looks to be especially hopping this spring, thanks to pent-up demand and buyers adjusting to higher mortgage rates. Here’s how you can prepare.
By Pam Krueger Published
-
Is 100 the New 70?
Eating well, exercising, getting plenty of sleep and managing chronic stress can help make you a SuperAger. Funding that long life requires longevity literacy.
By Phil Wright, Certified Fund Specialist Published
-
Nine Lessons to Be Learned From the Hilton Family Trust Contest
Disclaimers, good communication, post-marital agreements and more could help avoid conflict in a family after the owners of a wealthy estate pass away.
By John M. Goralka Published