by Bill Sweet
Continuing a conversation about fee disclosures for financial professionals (here, and here), fellow CFP® practitioner Michael Kitces wrote a great summary last week about how "problematic definitions and inconsistent application of [fee disclosure] rules have rendered compensation disclosure meaningless for consumers." His full and detailed article is here.
I am a fan of Michael's work. You can tell that he is serious about his job because he has enough certifications to begin a new alphabet, and he always makes it a point to pose for professional photos with an iPad for some reason. I'm not sure why he needs to broadcast his commitment to mobile technology, but regardless, this is one smart dude.
The ridiculous nature of this issue came to light for me about two years ago when the sitting chair of the CFP Board of Directors, Alan Goldfarb, resigned after violating his own organization's Rules of Conduct. Goldfarb held a 1% equity interest in an accounting firm that owned a broker-dealer, thus, even though he received zero compensation for this, was breaking his own organization's rules by holding himself out as a fee-only advisor. How this is relevant to his clients, I am not exactly sure, and if your head hurts thinking about this, so does mine.
If the rules of your organization are such that the president of your governing body has trouble figuring them out, I'm not sure what hope there is for the rest of us.
I strongly believe that all sources of compensation, regardless of the source, should be disclosed and discussed with the client. No exceptions. In my mind, it's less important how the advisor is compensated, but more important how that compensation impacts the relationship, quality of the advice, and how it affects the recommendations to the client.
I generally find other advisor's sanctimonious distinctions (usually delivered up on high from Mount Pious) to be self-serving. Granted, I do understand why some professional planners would want to create a distinction between what they do (provide fee-based advice) and how some salespeople act while seeking commission-based sales (see: The Wolf of Wall Street), but that's no reason to pass judgement on those who prefer a different business model.
Each arrangement has its pros and cons. For example, a fee-based planner whose revenue is a percentage of your assets under management has an incentive to gather as much of your money under her umbrella as possible, even if it isn't necessarily a good idea to do so. If their asset fee is 2%, and a money market deposit account is only earning 0.5%, you're "losing" 1.5% annually to hold cash with that advisor (granted, there might be other reasons to hold cash, but net-of-fee this is not a great idea for long stretches of time) before any inflation effects are calculated. One might get around this by negotiating a flat fee (my colleague James Osborne in Colorado is an interesting case study), but $4,500 per year is a large sum for someone starting out with a small amount of funds to invest.
I suppose that there is an inherent good in simply discussing the topic in the public, since in my experience few grasp all of the nuance here. And it certainly is good thing that clients have options and can choose the advisor that best fits them.
I am of the mind that fees are extremely important, since they are one of the few things that an investor can actually control. Yet at the end of the day, how your financial advisor is compensated is less important than what you receive in exchange of that compensation, regardless of the source.
Consumers should definitely be aware of how their advisor gets paid. But there is no perfect solution to this - every financial relationship has potential conflicts of interest that should be recognized and addressed, even in purely fee-only relationships.
Nobody manages your money for free.
-Bill
