Fee Vs. Commission—No Doubt Investors are Confused

A June 8, 2011 article in the trade journal Investment News, “Fee vs. commission: No doubt which investors prefer” cited a survey conducted by Cerrulli Associates asking investors about how they pay for investment advice and about their adviser’s standard of care. The article focuses on the finding that 47% of the 7,800 households surveyed prefer paying commissions. 

A number of industry insiders were quoted using this datum as vindication for their business model. The best was from Ira Hammerman, general counsel for the Securities Industry and Financial Markets Association, the lobbying group for the brokerage industry, “If you’re only going to trade five or seven times a year, it’s probably more economical for you to pay a commission as opposed to paying someone one percent of your assets as a management fee.”

Investment News should have asked the industry spokespeople about the 33% of investors surveyed who said they didn’t know how they pay for the investment advice they receive, and the 31% said they thought their advisor or broker provided investment advice for free. 

Really? 1 of 3 investors has no idea how they pay for their investment advice.  Even if they didn’t ask why, didn’t their advisor disclose this information up front?  Then there is another third who think they are getting their advice for free. Same question: Why was there no disclosure? 

About 64% of those surveyed said they believe their financial advisor is held to a fiduciary standard of care, and 63% of clients of the largest broker-dealers said they thought that as well. Brokers currently are only required to meet a standard to offer “suitable investments,” whereas registered investment advisors have a fiduciary obligation to put clients’ best interest first.

Cerruli Associates survey shows that 2/3 of the customers of the brokerage industry are unclear as to how they pay for the industry’s services. It also shows that 2/3 of the customers of the brokerage industry want the oversight of a fiduciary; think they have it and are wrong.

“Our clients have consistently indicated that they want choice in how they purchase and pay for wealth management services,” said Christine Pollack, a spokeswoman for Morgan Stanley Smith Barney, the world’s largest brokerage.

Framing this as an issue of consumer preference misses the larger issue of fiduciary duty when giving investment advice. It is only about consumer preference in the sense that so many would prefer to work with a financial advisor who puts the client’s best interest first.

But the brokerage industry resists because they are manufacturers and distributors of financial products. Typically, their network of advisors are rewarded more generously when they “advise” their clients to purchase the products produced by the firm as compared to other choices. The “suitability” standard allows this. It is very profitable and the brokerage industry would like it to remain that way.

Wall Street is fundamentally the same as Detroit. Detroit manufactures and distributes automobiles. Wall Street manufactures and distributes financial products. The difference is you don’t expect to be talking to someone who is looking out for your best interest when you are in a dealer show room.

Have a question about personal finance and investing? Send it to me at gpia@gepiaco.com.