Do You Know How Your Financial Adviser Gets Paid? Probably Not
If you keep a detailed household budget, you know how useful it is to be able to break down your expenses. Knowing precisely how and how much you pay for specific things can be a key first step on the road to personal financial health. But surprisingly few people are able to pinpoint how their financial advisers are paid, according to a survey released this week by research firm Cerulli Associates.Nearly two-thirds of survey respondents -- 64% -- either believed their financial adviser was providing their services free of charge when engaging in transactions on their behalf, or they weren't sure how their financial adviser was compensated.
It's not a trivial issue: How your financial adviser is compensated -- whether via commissions or advisory fees -- affects the rules they must adhere to, and the degree to which fiduciary standards require them to put the client's interest first.
Investment brokers and dealers, who tend to work on commission based on securities or products sold, are required to recommend products to their clients under a suitability standard, which is generally designed to align a person's net worth with the degree of riskiness they can tolerate in a particular investment. They are also required to disclose that the firm's interests may not always be in sync with those of the investors. Meanwhile, investment advisers, who are often paid a fee for their advice, are required to adhere to a fiduciary standard that mandates they put their client's interests ahead of their own or their firms.
The study, however, found that 63% of survey respondents who work with a broker-dealer or wirehouses believe their adviser is bound by those fiduciary requirements all the time. In reality, that requirement applies to those advisers only part of the time, notes the survey.
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"With a commission arrangement, there is always the temptation [for the broker dealer] to move product," says Scott Smith, Cerulli associate director. "I'm not saying this is what is happening with all commissioned advisers, but with a fee-based account, you don't have that worry because they get paid either way."Broker-dealers and wirehouses say only 13% of their clients have a fiduciary-only, or strictly fee-based investment adviser, relationship with them. In roughly 82% of the cases, the relationship involves a combination of a commission-based brokerage and fee-based advisory service -- which means the fiduciary standard applies only part of the time and only to the work performed under the fee arrangement.
Commissions Vs. Fees: Investors Are Split
That may soon change. The Securities and Exchange Commission is weighing the implementation of new requirements designed to apply a uniform fiduciary standard to both broker-dealers and fee-based financial advisers, under the Dodd-Frank Wall Street Reform and Consumer Protection Act. And, according to a Bloomberg report, the SEC is expected to propose a new rule standard regarding uniform fiduciary duties during the second half of this year. That SEC proposal, the report notes, is expected to continue to allow broker-dealers the freedom to receive commissions.
The survey found that despite the potential conflict of interest that can arise with commission-based compensation, nearly half of investors prefer it over paying asset-based fees to financial advisers. Nearly half of survey respondents, 47%, say they prefer paying commissions, while 43% said they would opt for fee-only financial advice. A small slice of 8% of survey respondents said they would want a mix of commission and fee-based services.
"Paying fees in perpetuity seems less attractive, but investors don't consider the services that go into a fee-based arrangement," says Smith. "A commission account may cost them 5% up front, versus a 1% fee that they may pay every year or two, or three or five years. And if the investor is reallocating their account every couple years, they may actually break even compared with a commission account."
