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Why do many consumers fail to understand the importance of obtaining fiduciary advice, despite its overwhelming value? The answer lies in the fact that traditional brokers are able to compete against fee-only advisors by articulating a simpler, easier to understand message.
A tired story helps make my point. The worn-out fable goes like this: some fee-only clients want to pay off their mortgage, but the advisor faces a monster conflict of interest. Any withdrawal of investments would reduce the advisor’s income, so he’ll (naturally) advise against paying off the mortgage.
That simple story is easy to understand, which explains why it just won’t die. But that simplicity also prescribes a streamlined remedy: Explain and discuss mortgage pros and cons. It’s the client’s money and decision. It’s doubtful any client will be influenced by an advisor’s obvious revenue needs! It’s akin to saying that a commissioned broker will suffer if a client decides not to buy. Lame.
The fee debate rages on
Fee-only advocates proclaim that divorcing sales charges from advice and service keeps their advice more objective.
Traditional brokers argue that sales or trading fees have historical precedent – a hundred years or more – plus a robust industry already serving millions of investors. No need to change what works so well. Besides, no fee scheme eliminates all conflicts of interest.
Both sides have passion. And, based on market share, traditionalists win many of the skirmishes. Part of the reason is that they are well-financed and buy powerful lobbying and advertising. A bigger part is that they own the easier message.
Conflicts of interest are foundational to this discussion
In the traditional brokerage industry, conflicts of interest are so intense, so massive, and so insidious that regulators, legislators, consumer groups and thoughtful advisors seek helpful remedies. Part of the reason for this is because conflicts can be almost invisible.
How so? For one thing, investments are complex. A single bond issuer can offer hundreds of bonds with varying maturities and interest rates. They can sound very safe (Detroit or Chicago, for instance, or your favorite university) and higher-than-normal interest rates look extra appealing. Yet, in the bond world, higher rates mean more risk, not less! A callable bond with a higher rate sounds inviting, right?
How might a novice investor evaluate conflicts when his broker offers up a “nice” bond for his portfolio? The rate seems stellar, the issuer sounds safe and there’s no sales commission. Looking over confirmations, he notices that the broker’s firm served as an agent for some transactions and a principal in others; what does that even mean?
Information imbalance creates the controversy
Richard Salmen served as chairman of the CFP Board in 2018. The board boasts over 80,000 CFP® professionals and it recently revised the code of ethics and standard of conduct for all member advisors. One of Salmen’s observations is that the most regulated professions (think medicine, law or public utilities) are ones where practitioners enjoy a significant knowledge advantage over consumers.
One implication is that wise public discourse is limited by that same knowledge disadvantage. It’s hard to discuss or even comprehend conflicts that aren’t fully visible. It’s hard to be indignant over a 12(b)1 fee if you don’t even know what it is!
Complexity helps maintain the status quo
The “no change” crowd benefits from this confusion. Investors aren’t clamoring for change because they don’t see what needs changing. Similarly, many public officials, regulators and watchdog groups don’t grasp the complexities.
I once helped a successful dentist evaluate the retirement plan offered through his trade group. He opened by explaining that the plan “was a good deal because it was marketed without sales commissions.” Digging through the prospectus (50+ pages, 10 point type) I discovered a page identifying a dozen separate fees charged against the accounts. (No direct sales commissions, though.)
Many fee-only professionals know and fully understand the conflicts and fees, even if their clients and prospects don’t. Yet, even with that knowledge, it’s not easy to explain their consequences. I often say that clients would always choose fee-for-service pricing “if they knew as much about the industry as I do.”
Simpler messaging helps maintain the status quo
A common competitive argument against fee-only advisors is easy-to-understand. Fee-only professionals tend to charge ongoing fees. This is true; most advisors charge an annual fee based on assets under management (AUM). That’s easy to grasp, right? It’s also easy to sell against, because of its ongoing nature.
Fee-only professionals are fiduciaries. They have an ongoing responsibility for the assets they manage. The relationship isn’t a “one and done” sales transaction. The responsibility, service and the modest fees are ongoing. It’s a level of service beyond the traditional model.
Transparent fees are almost always lower than hidden fees. So, a clear (ongoing) AUM fee – fully disclosed – frequently is less than multiple layers of sales commissions, trading fees, administrative charges and management fees from traditional brokers. Even if it’s not less, genuine fiduciary planning/management still offers ongoing services above and beyond the usual.
Better explanations drive better discussions
It’s easy for a traditional broker to sell against a fee-only relationship because the arguments are easy to make, explain and understand. They may lack merit, but it’s still an easy pitch. It’s much harder for a fee-only advisor to explain things that are nearly invisible or quite complicated.
Similarly, the industry environment favors traditional brokers because many public officials, regulators, and watchdog groups don’t grasp all the complexities, either.
Messaging drives the fee discussions.
Dan Danford, CFP® is an advisor in St. Joseph and Kansas City, Missouri. He learned about money from his late father Thad Danford who charged rent on the family lawn mower while Dan cut neighborhood lawns. Danford is also author of Stuck in the Middle: The Mistakes That Jeopardize Your Financial Success and How to Fix Them.
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