WV Executive

Among the many factors consumers consider when selecting financial advisors are the methods by which they are compensated. Although various ways of charging for financial services have evolved, commission-based sales transactions have historically been the most common. However, with the rise of the financial planning industry, the billing of hourly and/or percentage fees has become more common.

In some professions tangential to financial planning, fees are the norm. Traditionally, attorneys who create trusts and provide estate planning charge hourly or flat fees for their services. Accountants, who provide tax counsel, perform audits and prepare tax forms, typically charge hourly fees. Conversely, those who have provided insurance and investments have generally worked for salary and commission or exclusively for commission, with the latter being more common.

The difference in compensation methods in these professions appears to have come about because attorneys and accountants produce advice and documents while insurance and securities representatives have worked with advice and specific product sales. Into these traditions entered the financial planner midway in the last century. Although now a well recognized professional, the Certified Financial Planners’ remuneration systems are still evolving, no doubt because of the conflicting traditions of the fields with which planners interact.

Thus the question arises, which way of paying for financial services is best for the consumer? That is a reasonable question, but one with an answer that is difficult to discern. Behind the scenes, an ongoing and acrimonious debate among financial professionals over just that question is taking place. It began in earnest more than 20 years ago and its end is not in sight.

To Fee or Not to Fee

Most of those coming into financial planning as the profession first became formalized were entering the discipline from backgrounds in insurance and stock brokerage. They were used to the commission earnings culture in those professions. However, early financial planners were quite agreeable to receiving fees for service for their planning work and special services. After all, financial plans look more like the products of legal and accounting practices, being built as they are around documentation and detailed advice.

While views today are divergent on compensation arrangements, the options themselves have distilled into five basic categories of which consumers should be aware. They are: (a.) commissions only (b.) fees only (c.) fees offset by commissions (d.) fees and commissions (e.) client’s option of fees or commissions. Which is best? That remains up for discussion and personal point of view.

Some Certified Financial Planners have concluded that charging hourly and percentage fees for financial planning and investment management is the only acceptable way for a planner to be compensated. They contend that when varying commissions from competing products and methodologies are at stake, conflicts of interest arise that could work against the client’s financial well-being. Fee-only planners theorize that they sit on the same side of the table as their clients in that they can easily be objective.

Fee-only planners also discourage what they consider to be “high commission products.” They cite that not only do such investments take too big an up front bite out of client capital, the commission costs involved present an exit problem if one wants to change positions soon after acquiring them.

Devotees to the fee-only cause have exhibited an evangelical conviction to their position. Meanwhile, their non-believer professional counterparts scoff and dismiss them as conspiracy theorists.

Opponents of the fee-only position argue that such planners often try to increase their profits by managing portfolios too often by themselves rather than pairing their clients with more competent outside managers and sharing the fees.

The anti-fee only planner crowd also contends that fee-only advisors limit their scope and ability when they are not securities and insurance licensed. The theory goes that fee-only planners often do not consider seriously insurance and other important commissioned financial products, such as alternative investments, to the detriment of their clients’ financial progress. Further, they point out that many well-regarded insurance and securities products structured to pay commissions up front will see their commission costs calculate to be less over time than the mounting cost of ongoing fees. They also reason that since products of this sort do not meld into the fee-only environment well, they must be ignored by such advisors to the disadvantage of their clientele.

Alphabet Soup Digest

When the International Association of Financial Planners (IAFP), the financial planning profession’s largest professional organization was drawn into the compensation debate, it elected to abstain. The IAFP took the position that compensation was an individual planner or individual practice matter and the planner’s skills and integrity are what really matter to the consumer.

In 2000, the IAFP merged with the Institute of Certified Financial Planners (ICFP), then the second largest professional group in the field. The merged society was named the Financial Planning Association (FPA). Neither the IAFP, nor the ICFP, nor the FPA ever endorsed the fee-only dissident group’s position. In fact, the dissident group of fee-only planners formed its own professional association. They named it The Association of Fee Only Advisors (AFOA) and it has gradually grown to have about 1,000 practicing members.

Meanwhile, the FPA has become more active and influential since its creation. It currently boasts a membership of more than 27,000 financial and allied field professionals. Most of its members and all of its board members are Certified Financial Planners, a group itself that now numbers more than 50,000. Standards are high and the organization demands objectivity, competency and integrity from its membership, as does CFP certification.

Regardless of any lack of merit to the AFOA’s position that may or may not exist, a gradual migration by financial professionals to fee-oriented practices is occurring and has been for some time. The most common structure for financial planner compensation these days involves some blend of fees and commissions, depending on the services rendered and the culture of the company creating the investment products being utilized.

So Why the Move to Fees?

The vast majority of independent advisors that are moving their work into a recurring-fee business format are doing so for three main reasons and objectivity is not one of them. The salient goals actually are: to increase practice value, to enhance marketing and to attain simplification.

The reason assuring planner impartiality has nothing to do with most of those moving to fees is that virtually all planners believe they are impartial and objective in the first place. In fact, surveys have shown that professionals making the switch to at least some fee income see themselves as only having been influenced by client requirements in planning as well as investment and insurance advice.

The inside story here is that the issue advisors are considering most is how the market value of an advisor’s practice is determined. This becomes important to an advisor/owner at retirement or in the event of serious illness or disability while actively working. In fact, even a consulting industry for the resale of financial planning practices has arisen in the last few years.

Financial planning practices are selling currently for two to four times their annual gross fee based revenue. On the other hand, a buyer will pay only about half of a commission- based practice’s annual gross revenue because commission income is seen as individual driven and therefore less stable. When one pencils the math, a fee-only practice is currently worth four to eight times more than an exclusively commission shop having the same annual gross revenue.

The dependability of fee income is so alluring these days that it is even driving the large brand name securities brokerage companies to redirect their stock and bond sales forces to aggressively pursue fee business. Their aim is not resale value but dependable revenue. Some employees of these firms have already experienced fee remuneration in the past from the percentage arrangements charged for institutionally managed individual accounts. The fee bug has not bitten the insurance industry yet, but it may.

A second reason that independent financial planners are moving to fee billing is the marketing angle that arises for fee-only and fee-based planners. This derives from the claim made by fee-only practice devotees that there exists a greater objectivity in their work. This position further implies that professionals receiving commissions are or may be conflicted. Of course, there is no empirical evidence of this and there may well be as many fee-only planners per capita that are mediocre and self-centered in their work as planners paid in the other ways. No one knows. Nevertheless, this posturing provides an advertising story that can have a degree of appeal to some consumers and financial writers alike.

The third reason advisors are lured to the fee structure is that managing sundry portfolios and other client services in the fee environment is simpler. Billing is regularly and unobtrusively deducted from client accounts, with a clockwork precision. In fact, independent advisors and those in large brokerage companies and banks that receive fee-only or fee-dominated compensation know the approximate minimum annual income to expect at the year’s outset. The presumption is that they sleep better as a result.

In the final analysis, the debate on compensation options will likely be a tempest in a teapot for most consumers. The reality is that competent financial professionals tend to be paid well and planners’ incomes generally tend to be about the same for a given volume of business over time, regardless of compensation method. If it were not so, a universal move by practitioners to the clear winner in the compensation contest would have already occurred.

Nevertheless, consumers should always satisfy themselves that they understand completely how their personal advisors are remunerated. They should feel comfortable that the compensation is fair and acceptable to them. Once that satisfaction is attained, one’s interest is probably best served by focusing attention on securities’ prospectuses/offering documents and the advisor’s training, experience, integrity, references, as well as after expense results for similarly situated clients.