Fees vs. Commissions: Why An Old Debate Is New Again
Robo-advisors are forcing us to revisit the ancient fees versus commissions debate. New data and new circumstances have changed the debate in powerful ways.
How? Let’s start with the middle market. Historically, defenders of commissions have persistently asserted that it’s impossible to deliver investment advice, profitably, to middle-market consumers if you only charge fees for your services.
Even in the olden days before robo-advisory platforms, it took a certain amount of courage to make this assertion. If you sell a small annuity and pocket a $300 commission, how is that more efficient than receiving a $300 check from the client for your recommendation of comparable mutual funds or ETFs?
Meanwhile, advisors all around the country have been refuting this argument for decades through their normal business practices. The Garrett Planning Network and Alliance of Comprehensive Advisors have been working with non-wealthy clients for years on a fee basis. More recently, the XY Planning Network of advisors has been charging subscription fees to younger Gen X/Y clients who have far more credit card debt than investible assets. This, at least, suggests that fee compensation is compatible with the middle market and even with those who have assets at all.
But even granting the validity that sales is somehow more efficient than fee-compensated advice when both are delivered face-to-face, we now have a plethora of online advice platforms that are willing to deliver relatively sophisticated investment services to non-wealthy customers on an AUM- (that is, pure fee) basis. Middle market consumers can get investment services from Betterment, Wealthfront or one of the competitors that are sprouting up like mushrooms after a warm summer rain.
This is a game-changer. You can no longer argue that someone has to charge commissions in order to provide services to the vast majority of Americans.
Fees in the middle market
The other argument in favor of commissions is that, aside from a small number of advisors in the aforementioned networks, most fee-compensated planning professionals are working almost exclusively with wealthier clients who meet minimums of $500,000 all the way up into the multi-millions in investible assets.
Historically, this has been an uncomfortable truth for the proponents of the fee-only model. But here again, the circumstances on the ground are changing. In the very near future, I expect that a lot of advisory firms will incorporate institutional versions of robo-technology into their practices, driving down internal costs and allowing more firms to provide basic investment advice to clients who have very little money to invest. It’s possible that fee-only advisors will be serving the blue ocean of younger, less-wealthy potential clients en masse within five years. The technology is there to completely revise the cost-benefit equation in the fee-only revenue model.
The final argument in favor of commissions is an emotional one. Every once in a while, I’m confronted at an industry conference by somebody who angrily asks me why I “hate commissions.” I don’t; in fact, I don’t have any emotional connection with any form of compensation in the advisory business. My consistent position, over the years, is that commissions don’t represent the future of the profession, because they create incentives not to put the best interests of the client first. This emotional misreading of my words (and of others’) suggests that someone has convinced a lot of reps that they’re being unfairly persecuted – even demonized – for their choice of revenue model.
Is it true that fees are the future of the profession? Fifteen or 20 years ago, it was not easy to find clear evidence in favor of this position. Once again, new circumstances have changed the debate.
Today, it’s possible to look back over 35 years and see that there has, indeed, been a visible migration among advisors and planners from commissions to fees. No longer do you hear reps at industry conferences boast about their “production levels” as you did back in the 1980s and early 1990s. The number of fee-only planners has grown from fewer than 100 during the tax-shelter limited-partnership days to roughly a fifth of all advisors registered with the SEC, according to the latest data compiled by Tiburon Associates.
Many dually-registered reps are now primarily compensated by an AUM revenue model, and every independent broker-dealer has its own asset management platform to serve them. According to the various broker-dealer surveys in the industry magazines, fees represent the fastest-growing segment of broker-dealer revenues, virtually across the board.
At the same time, the ranks of brokerage firms—the primary bastions of commission compensation-- are thinning rapidly. Rest in peace E.F. Hutton (1904-1988), Drexel Burnham Lambert (1838-1990), Shearson (1902-1994), Kidder, Peabody (1865-1994), Salomon Brothers (1910-2003), Lehman Brothers (1850-2008), Bear Stearns (1923-2008), Dean Witter Reynolds (1924-2009) and Prudential Securities (1879-2011).
The point here is that it is finally possible to identify a clear trend from commissions to fees in the profession. Before, those on the commission side of the debate might have challenged the idea that commissions are on the decline as a component of advisor compensation, and argued that fees are not the future of the profession. They can’t make that argument any more.