How are no-fee financial advisors compensated?

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How are no-fee financial advisors compensated?

Postby Browser » Fri Dec 28, 2012 1:18 pm

I'm generally aware that the majority of FAs are no-fee and make their money by getting a cut of the funds they put their clients into. But I don't understand the specifics of how that works and what their cut is. Do they collect a one-time "commission" from fund providers? Do they purvey special share classes of the funds that have a higher ER and get an on-going "royalty" of sorts? I'd appreciate knowing more about how their incentives are structured. I don't personally use an FA, but have friends who do and I don't think they have a clue how their FA is making a living off of them. I guess they think the FA works on a pro bono basis. :mrgreen:
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: How are no-fee financial advisors compensated?

Postby dbr » Fri Dec 28, 2012 1:23 pm

You can look for a 12b-1 fee in the ER.

Probably the biggest cut comes from loads on fund, which is a mechanism for the FA to take a cut of the purchase when it is made, often as much as 5%. Google for A, B, and C share classes.

There can also be commissions at brokers.
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Re: How are no-fee financial advisors compensated?

Postby Default User BR » Fri Dec 28, 2012 3:19 pm

Don't forget 12b-1 fees. A portion of the inflated expense ratio goes to the broker.


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Re: How are no-fee financial advisors compensated?

Postby pkcrafter » Fri Dec 28, 2012 7:51 pm

Browser wrote:I'm generally aware that the majority of FAs are no-fee and make their money by getting a cut of the funds they put their clients into. But I don't understand the specifics of how that works and what their cut is. Do they collect a one-time "commission" from fund providers? Do they purvey special share classes of the funds that have a higher ER and get an on-going "royalty" of sorts? I'd appreciate knowing more about how their incentives are structured. I don't personally use an FA, but have friends who do and I don't think they have a clue how their FA is making a living off of them. I guess they think the FA works on a pro bono basis. :mrgreen:


I've heard variations of this several times, from advisors and clients who actually believe them: You don't pay me, the mutual fund company does.
This is completely deceptive and any advisor saying this should be immediately be rejected. To make is worse, most of the advisors who do this are brokers with no fiduciary duty. Investor beware.

This article might shed some light on how advisors are paid.

https://blog.wealthfront.com/advisor-paid-returns-part-ii/

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Re: How are no-fee financial advisors compensated?

Postby dhodson » Fri Dec 28, 2012 8:04 pm

Whenever someone pretends you aren't paying the fees/commission, you can pretty much guarantee the product being sold isn't in your best interest otherwise there is no reason to pretend.
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Re: How are no-fee financial advisors compensated?

Postby Beat The Street » Sat Dec 29, 2012 1:23 am

As someone who works in the industry I can't tell you how many times a prospective client has told me that their current FA isn't charging them anything, then they bring in their statements loaded up with C shares.
“Never ask anyone for their opinion, forecast, or recommendation. Just ask them what they have—or don’t have—in their portfolio.” -Taleb
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Re: How are no-fee financial advisors compensated?

Postby Browser » Sat Dec 29, 2012 9:53 am

Beat The Street wrote:As someone who works in the industry I can't tell you how many times a prospective client has told me that their current FA isn't charging them anything, then they bring in their statements loaded up with C shares.

What are C shares? A problem in my area is that there aren't any fee-only advisors that I can tell. These are rare birds. The money must be in the no-fee game.
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: How are no-fee financial advisors compensated?

Postby JW Nearly Retired » Sat Dec 29, 2012 10:21 am

Google A-shares, B-shares, or C-shares to see the fees for each.
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Re: How are no-fee financial advisors compensated?

Postby Beat The Street » Sat Dec 29, 2012 11:35 am

What are C shares? A problem in my area is that there aren't any fee-only advisors that I can tell. These are rare birds. The money must be in the no-fee game.[/quote]

C shares have no upfront sales charge but a deferred sales charge for 1 year. The advisor usually gets a 1% commission upfront and 1% on going each year (all of this is hidden in fund expenses). Since there is no upfront load the annual expenses of the fund are higher and they never decline. A shares have an upfront load (as high as 5.75%) but no back end fees, still ongoing fund expenses probably over 1% per year though. B shares are a rarity now but are still offered by some fund families. They have no upfront load but a deferred load for usually 7 years but the advisor gets paid like they sold an A share. Again the annual operating expenses are much higher for B shares and they convert to A shares after 7 years.

Find someone that will work on a fee to avoid high commissions and expensive funds and I probably wouldn't pay more than 1% unless you think they are worth it. The problem is that unless you have a 7 figure account most advisors will charge you over 1% so it may be best to for you to get as educated as you can and do it yourself but if you think an advisor can do 1% better than you can do, use an advisor.
“Never ask anyone for their opinion, forecast, or recommendation. Just ask them what they have—or don’t have—in their portfolio.” -Taleb
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Re: How are no-fee financial advisors compensated?

Postby Dandy » Sat Dec 29, 2012 11:52 am

Many funds are sold with Class A, B or C shares. For class A shares the buyer pays a load of a few % on each investment and a portion of that goes to the FA. Class B shares are sold without an INITIAL load. The fund company technically borrows money to pay the commision related expenses. They recapture their loan (and more) by charging a 12b1 on the buyers class B fund balance for a number of years. e.g. they may chare a 1% 12b1 fee for 6 years to cover the commission related payments and "interest" on their loan. If the buyer decides to sell Class B shares before the firm has captured all their expenses and interest there is a declining surrender charge.

Class B shares used to collect the 12b1 fee forever but I believe most convert to Class A shares after a "reasonable" period. For the same fund class A shares will pay a higher dividend since there is no 12ba fee.

FAs like to sell Class B shares since if you invest $10,000 your confirm shows that amount has been invested for you vs when selling Class A shares it might show only $9,500 has been invested for you. i.e. 10k less $500 load. It is always better for the seller to have the fee hidden. Imagine the outcry if banks published their hidden loads on savings or CDs -they are crediting say 1% on a CD and loaning that money out at several times that.

Class C shares are a combo usually a 1% upfront load and a 1 year 12b1 fee. Not too popular.

That is why it is better to buy true no load funds especially index funds. The expense ratio is a good but incomplete indicator of what you are paying for the fund.
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Re: How are no-fee financial advisors compensated?

Postby Browser » Sat Dec 29, 2012 12:08 pm

I liked Beat the Street's analysis: figure out what the FA is costing you. If you think he's earning that much or more than you could do on your own then stick with him. Maybe a small tip for the comfort provided by hand-holding if that floats your boat. My guess is by that standard it would be very unlikely that the value added by working with an FA comes even close to what you're paying them. Perhaps a fee-only FA is worth considering because at least you can figure out what you're paying for his services, but the costs of a no-fee advisor are hidden so you don't really know; except that I'll bet it's way more than 1%. How do you communicate this to someone who needs to believe that an FA is a High Priest of Investment with the keys to the temple? I have friends like that I'd like to save, but I don't know how to do it.
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: How are no-fee financial advisors compensated?

Postby pkcrafter » Sat Dec 29, 2012 12:22 pm

Code: Select all
What are C shares? A problem in my area is that there aren't any fee-only advisors that I can tell. These are rare birds. The money must be in the no-fee game.

There is no such thing as a no-fee advisory service. Any advisor claiming the investor does not pay is being deceptive. A, B, and C shares are all classes of commissions attached to mutual fund purchases. Of the three, C shares are the most sinister. The commission on this class is typically 1% added to the 12-b1 fee, which is embedded in the expense ratio. So, C class mutual funds will usually have expense ratios near or above 2%.

Information on commission-based share classes.

http://www.finra.org/investors/protectyourself/investoralerts/mutualfunds/p006022

If you are looking for a fee-only advisor, try Garrett Planning Network

http://garrettplanningnetwork.com/

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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