Investment Management: Fee vs.

Commission
By Rick ODell

Financial Advisors (FAs) receive compensation for his or her services in different ways, often leading to confusion for the investor. The most common forms of compensation include fee based, commission (or transaction) based or a combination of the two. Due to the fact that there are many similarities between FAs who charge a fee and those who work on commission, it is important to understand the compensation arrangement because this leads to key and compelling differences in service and what you may own in your portfolio. Typically, FAs who charge a fee represent a process and those who work on commission represent a product. Thats not to say that commission advisors do not have a process, but the process involved often lacks in comparison with that of a fee advisor. A thorough and meaningful process should include the following: 1) A no cost or obligation introductory meeting to gain a clear understanding of the clients goals and objectives; 2) An Investment Policy Statement (IPS) to establish the investment guidelines; 3) A research team that develops forward looking assumptions; 4) Optimization of asset allocation; 5) Periodic rebalancing of portfolio to maintain desired allocations; 6) Institutional strategies regarding investment products; 7) Ongoing maintenance and monitoring.

What is meant by representing a product? Commission advisors may use a certain product (mutual fund, annuity, insurance) repeatedly due to an established relationship with the product vendor or company. Although the commission advisor has the ability to use a wide assortment of products, he or she may fall back to those that they are most familiar with. This knowledge with certain products or vendors can lead to resistance or hesitance in changing even when warranted. Years of this practice can lead to a book of business heavily concentrated with one vendor or companys product.

Before committing to a relationship, or even if you are in an existing relationship with an advisor and are not clear on how he or she is compensated, ask the FA the following questions: Fee based FA: What is your management process? How often can I expect communication? What fee will I pay? Do you offer a reduction for larger deposits? Where can I see my costs (fee)? Commission based FA: Which vendor or company products do you use most often? Why? Which vendor or company(s) does your firm have a revenue sharing relationship with? What is the commission? Are there ongoing expenses as well? Where can I see my costs (commission)? Obviously, there are arguments that favor both forms of compensation. I tend to favor those that are most compelling. I find it more compelling that the advisor that is paid the bulk of his or her compensation up front (commission) could be less likely to provide a high level of ongoing service than the advisor that collects no commission up front but receives an ongoing fee. I find it more compelling that an advisors incentives are more aligned with the clients objectives when the only way his or her compensation increases is if the clients portfolio value increases (fee) and compensation decreases if the portfolio value decreases. A commission advisor can increase his or her compensation through a higher number of transactions (portfolio turnover), regardless of the clients account performance. I also find it more compelling that commission advisors spend more time hunting for new money to invest (new clients or additional money from existing clients) than servicing existing portfolios, which they are receiving little or no ongoing compensation for. A fee advisor could have more to lose if a client leaves because his or her income will drop as compared to the commission advisor who was paid up front. If you are a cost conscience investor, you will want to know which type of advisor, fee or commission, will cost you the most. This is a great question but the answer is, it depends. It depends on how long you are with the advisor, how many transactions per year you typically incur, how much in assets you are investing and what type of products you are purchasing. If you buy one product, pay the commission up front and keep it for many years, you will typically pay the least amount in expenses. In todays world with changing products, increased market volatility and economic uncertainty, this strategy may not be as practical as in years past. Ask your FA what you are paying and make sure you fully understand all of your expenses. Ask him or her to show you how you can see your costs (some expenses are not readily transparent).

Once you fully understand all of your expenses, then you can make a determination about the relationship and the value you feel you are receiving. In my opinion, the best client/advisor relationships combine a deep understanding of the clients goals, objectives and risk tolerance; a high level of service; timely and periodic communication; suitable advice and fair compensation. If any of those components are missing it is likely to lead to dissatisfaction for the client, the advisor or both. If you feel confident with your current advisor, understand fully how they are being compensated and are satisfied, then stay put. Be wary of the FA who competes for your business by claiming to be less expensive. The problem here is that they are rarely less expensive when you consider the total expenses (including those that may not be visible), investment management processes, level of service and experience. My last compelling find, the best is rarely the cheapest and the cheapest is rarely the best.

About the Author: Rick ODell is a Financial Advisor, Accredited Asset Management Specialist (AAMS) and General Securities Principal with Raymond James Financial Services, Inc. Member FINRA/SIPC. He holds a Bachelors Degree in Business Administration and has nearly 20 ye ars of experience working with successful individual investors and families.

Clients should periodically re-evaluate whether the use of an asset based fee continues to be appropriate in servicing their needs. A list of additional considerations, as well as the fee schedule , is available in the firms Form ADV Part II as well as the client agreement.

ODell Capital Management is located at 858 W. Main St. Hillsboro, OH. 45133