Blurring the Lines

December 1, 2017

How much are investors really paying Wall Street?

Surveys from groups such as J.D. Power & Associates report that well over half of all investors don’t know how much they are paying their financial adviser. In its quest for profits, the entire financial services industry is finding ways to hide fees and to skirt the historical distinction between ‘fee only advisors’ and ‘commission based brokers.’

A fee only advisor (Registered Investment Advisor, aka RIA) receives a fee (either a fixed dollar amount or a percentage of the assets under management) for acting as both a fiduciary and managing a client’s investments. The amount of the fee is transparent, and acting as a fiduciary, the RIA has a legal obligation to put the client’s well-being first and foremost. Stock brokers, traditionally, market investments and in return receive a sales commission. The investment must be considered “suitable” for the investor but a stock broker has no fiduciary obligation to a client. This distinction enables brokers to utilize less transparent investments that may provide much greater compensation to the broker than does an alternative product.

The distinction between RIAs and brokers has become blurred in today’s financial services industry. Many firms now operate as both a RIA and a broker. Often, they will refer to themselves as “fee based” since they are not “fee only”. They blur the line between the fiduciary rule and the “suitability” rule. This allows them to mix ‘commission’ based products with some ‘fee only’ products. This confused structure is less transparent and often leaves an investor with an incomplete understanding of how much they actual pay their financial adviser.

At the same time, some firms have also been cleverly shifting some of their operating costs from the advisory firm onto the back of the client. Shifting traditional business costs from the adviser firm onto the back of the investor is the same as charging higher fees. A common means of doing this is to utilize mutual funds that have 12b-1 fees. The fee is deducted daily, directly from an investor’s mutual fund and paid to brokers and custodians to subsidize the adviser’s expenses. This fee is usually 0.35% per year and allows an advisor to avoid paying transaction costs and/or reduces the amount the adviser pays to the custodian (usually a discount broker) for clearing trades and safekeeping assets.

Don’t be surprised if you never heard of 12b-1 fees, unlike commissions, 12b-1 fees do not appear on transaction confirmations or client’s account statements. The explanation of these fees is usually buried deep inside an annual report or prospectus.

Be skeptical. If the adviser appears to be parsing his words carefully or he offers some complicated explanation about his compensation, ask for a written explanation of all fees associated with your investments and the maintenance of your account. This should include at the least the advisor fee, the sub-advisor fee, 12b-1 fees, and all commissions associated with your investments, especially with any variable annuities. Remember the words of Oliver Wendall Holmes, Sr. “Truth, when not sought after, rarely comes to light.”