Should You Invest with a Commissioned Broker? Maybe
September 20, 2012I recently had dinner with a friend of mine who just got a job working for an investment brokerage firm. Yes, that means she’s going to be one of those commissioned brokers that I’ve warned so much about. (If they work for a brokerage firm, they’re a broker even if they call themselves something else.) Ironically, she was looking for some advice from me in getting clients and building her business. Did I tell her to forget it and join a fee-only financial planning firm? No. In fact, there are some very good reasons why an investor could be better off with a broker than one of the many fee-only advisers she’s competing against:
1) Existing Relationship: You or a close friend or family member may already have a great working relationship with a broker that you trust. Finding a trusted adviser isn’t easy. Don’t underestimate the value of this.
2) Access: The fact is that not everyone has access to a fee-only adviser. Many of these advisers have asset minimums of $500k or even $1 million. If they are willing to take a smaller investor, those clients are usually relegated to a lower service level and are often assigned to a junior associate. While there are advisers who charge hourly or annual retainers, there aren’t many of them so a local one can be hard to come by.
3) Cost: One of the most important factors in investment success is keeping costs low. Most fee-only advisers charge an asset management fee of typically around 1%. To put that in perspective, a $250k portfolio earning a 6% rate of return minus a 1% annual management fee would be worth just under $850k in 25 years. Not bad. But that same portfolio without the 1% fee would be worth over $1 million! That investor would basically be giving up their entire initial portfolio to work with that fee-only adviser. However, after paying a 3% upfront load to purchase funds from a commissioned broker, the portfolio would still be worth over a $1 million in 25 years. That advantage would be even greater if the investor purchased individual stocks and bonds from the broker, avoiding the various fees and other costs associated with mutual funds that could add up to as much as 3% a year.
4) Unique Investment Options: When I was a commissioned broker, I would sometimes sell variable annuities with a guaranteed minimum income benefit based on a 7% minimum annual return. Yes, the annuity fees were expensive but the people buying them tended to be afraid of investing much or even anything in the stock market at all. I used to use a guard rail analogy. Have you ever seen a car hit a guard rail? Now imagine driving across a high bridge with no guard rail. How slowly would you drive? The point is that even though the chance of needing the guard rail is pretty slim, having it there gives us the confidence to drive faster. In the same way, these annuities allowed people to invest more aggressively that otherwise would be keeping all their money in CDs currently paying less than 1%. As far as I know, annuities like these are only available through commissioned brokers because they’re too complex for many people to buy on their own. The same is true for many whole life insurance policies.
5) Control: Many fee-only advisers require that they have discretionary trading authority over your account. Basically, that means they can make trades without asking for your permission. With a broker, you stay in the driver’s seat. (This can actually be a disadvantage for a lot of people.)
If you’re considering working with a broker, here are some things to look for:
1) What’s their background? You can do a free search for a history of a broker’s employment and “certain criminal matters; regulatory actions; civil judicial proceedings; customer complaints, arbitrations, or civil litigations; employment terminations; and financial matters in which the broker has been involved” at FINRA’s BrokerCheck®, site. Make sure the adviser can sufficiently explain any red flags you see.
2) Do they have a respected financial planning designation like a CFP®, ChFC, or CPA/PFS? Since the barrier to entry to become a broker is fairly low, these certifications let you know that the broker has at least passed a minimum threshold of education, experience, and ethical qualifications.
3) How independent are they? While all brokers face some conflicts of interest, some are more conflicted than others. Specifically, you want to make sure that they have access to a wide variety of products and services from many different companies. Otherwise, if they only sell mutual funds from one company, those funds can start looking like the solution to every problem.
4) Do they charge asset management fees in addition to commissions? Yes, some brokers like to double-dip and will often call themselves “fee-based.” Obviously, this can turn the cost advantage of using a broker into a disadvantage.
5) Are they interested in your goals or just in selling you something? You can tell this in the way they interact with you. Are they asking about your goals or just how much money you have to invest? Do they do a thorough analysis before making a recommendation? If not, run away. There are plenty of other brokers out there that will treat you right.
I’m not saying that everyone should switch to a commissioned broker. (I personally still think an hourly fee or annual retainer offers the best deal for most people.) My point is that there are valid reasons that someone might choose to work with one over a fee-only adviser that charges an asset management fee. As with most financial matters, it all depends on your situation.