When it comes to stock brokers pushing mutual funds, and Investment Advisors pushing those same mutual funds, the feeling is definitely not mutual.

Okay, that’s a serious overuse of the word mutual, but I feel it’s in your best interest as a responsible investor to know the difference between the two worlds of peddling mutual funds. And you may be surprised at what you discover.

A few weeks ago I had a very interesting conversation with a colleague and he shared this story with me.

Watson sits on the endowment committee for his local church in Cleveland and they work with a very well-known national stock brokerage firm – whose moniker is a Bull – managing the church’s investments.

The church’s endowment fund has a ton of money invested in a C-Share mutual fund called the Pimco Total Return Fund. Now, if you’ve never heard of a C-Share mutual fund it’s a level load fund that does not have an upfront sales charge, but normally sports a 1% annual fee.

(This fee is called a 12B-1 Fee in the industry, which is considered an annual marketing or distribution fee that is usually built into the fund and basically hidden from the investor. The broker gets paid 1% when the investor buys the fund and then the broker gets paid 1% each anniversary as long as the investor owns the fund. So for example, if the fund earned 10%, the broker is paid 1% off the top and the investor nets 9%. So the investor never sees the fee coming out of their account, since it gets sliced off the top throughout the course of the year. Pretty slick, huh?)

Anyhow, when Watson goes to meet the brokers at this big Bull firm he asks, Why don’t you consider using exchange-traded funds instead of mutual funds?”

The shocked look on his broker’s face was priceless. The broker answers, “I don’t use exchange-traded funds because the Church would have to pay a commission on the buy.”

“What would that commission be?” asked Watson.

The broker replied, “Even after giving a healthy discount, the commission would be more than 1%.”

This story took me back about a decade. That’s when I left a big name brokerage firm where those were the commissions that clients were paying at the time.

Let’s examine this situation in more detail. What we’re basically talking about is a church endowment fund that owned the Pimco Total Return Fund, (Class-C). That fund is a very well-known bond fund with an annual internal expense of 1.6% per year. Now with C-Shares you’re paying a 1% 12B-1 fee every year you own the fund.

So for example if you had $150,000 invested in the Pimco Total Return Fund, Class-C, you paid $1,500 every single year you own the fund. Remember this fee is invisible and built directly into the fund. And if you owned the fund for three years you’d have paid $4,500 in fees just for the privilege of owning this fund. Let me repeat that: $4,500 in fees.

Now let’s flip over to the other side of the spectrum. That same Pimco Total Return Fund is now available as an exchange-traded fund. With an exchange-traded fund, you pay a commission to buy and sell the fund. Typically the internal fee cost structure associated with an exchanged-traded fund is much less than the cost associated with a mutual fund.

So if your investment advisor places trades through the discount broker (and they should), you’ll find that the “BIG” that the brokers charge at the large brokerage firm might be around $15-$16. It could even be free because many of the discount brokerage firms are offering exchange-traded funds without any commission at all.

In the end, you’ll find that a fee-only investment advisor will always try to minimize your trading costs. A broker on the other hand must get paid. For instance, a broker’s wrap-fee program (if you read the fine print) includes fees as opposed to commissions. The big brokerage firms estimate that a client would pay 2.5% in commissions just buying and selling. So they’re just going to take the 2.5% and smooth it out and charge the client .625% in four quarterly installments instead of paying a commission per trade. When you read the fine print you’ll see that the fee is not for investment advice, it’s for fees as a replacement for commissions.

Since 2002, I’ve told clients that brokers do not win awards, perks or get recognition for making the most money for their clients. The sad fact is they receive recognition, a larger office and a better sales assistant for generating the MOST REVENUE FOR THEIR FIRM. Brokers are employees of the brokerage house. Their job is to increase revenue year after year after year.

On the other hand, an investment advisor may charge a fee based on the value of your account, but that fee is for investment advice and not necessarily for transaction costs or commissions. Generally an investment advisor works with a discount firm in an effort to minimize your transaction costs. And that’s what an investment advisor should do since their fee is typically based on the assets in your account. They want your assets to grow each and every year. If they try their best to minimize your trading costs it just makes more sense for all parties involved.

Bottom line: Remember that when brokers are compensated in the manner they are it could distort the product or offering that they are putting in front of you.

As Watson and his church discovered, they were paying dearly for a mutual fund when an exchanged-traded fund may have been the optimal choice.