For Financial Advisors

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Overview of Pay by Assets: Since the early 1990s, an increasingly popular option for financial advisor pay is based upon the value of the financial assets in the client’s account. This method, where available, usually is at the client’s option, as an alternative to traditional transaction based commissions.

Please note that financial advisor is used as a title for both investment brokers subject to the suitability standard and registered investment advisors subject to the fiduciary standard. While commission based client relationships are the long established norm among the former, the latter traditionally work on a fee only basis.

Leading securities brokerage firms began offering this pricing alternative as part of a concerted push to smooth out their revenues and earnings (which they often refer to as annuitizing revenues), dampening the more pronounced swings that may result when commissions are their primary source of client revenues. Note, however, that mark to market movements in the value of client assets will necessarily cause the fees charged on client accounts to move in the same direction.

Asset based fees normally differ based on the category of assets in the account, with cash drawing the lowest (or no) fee, fixed income being charged a higher fee, and equities the highest fee. The fees typically are paid in several installments during the year (monthly or quarterly), and the asset base to which they are applied may represent either a point in time (snapshot) measure or an average balance over the period in question.

Advantages to the Client: Clients who have more actively traded accounts tend to prefer paying asset based fees over traditional commissions. which can be much more costly. Moreover, clients who prefer to pay based on assets see it as aligning the financial advisor’s interests more closely with their own. That is:

• The financial advisor does not have an economic interest in increasing commissions through excessive trading, which is known as churning an account.
• The financial advisor, instead, has a direct economic interest in increasing the value of the client’s account.

Advantages to the Financial Advisor: With asset based fees, the financial advisor theoretically can count on a much more stable and predictable flow of compensation than can be expected under traditional commission based pricing. Additionally, the financial advisor is not under constant pressure to pitch transactions to the client in order to boost his or her revenues and compensation. On the other hand, the financial advisor does have an ongoing imperative to gather more assets that the client may be holding elsewhere, in order to increase his or her revenues and pay.

Conflicts of Interest: While initially promoted as a way to overcome the conflicts of interest inherent with commission based financial advisor pay, asset based fees introduce other potential conflicts:

• The financial advisor has incentives to allocate an excessive amount of the client€™s portfolio to equities, on which the highest fee is paid.
• The financial advisor also has incentives to reduce the amount held by the client in cash, since the fee paid on cash balances typically is zero or close to zero.
• The financial advisor has disincentives to recommend the removal of assets from the account to invest elsewhere, such as in the purchase of a life insurance policy or of real estate, even if that would benefit the client.
• The imperative to increase client assets may encourage excessively risk loving (as opposed to risk averse behavior on the part of the financial advisor.

Prevalence: Among registered investment advisors operating on a fiduciary basis who serve individual clients and have at least $25 million in client assets. the percentage of those who get paid only by this method has been:

• 11% in 2010
• 10% in 2009
• 9% in 2008

This data is derived from a study by Dr. Lukas Dean, Assistant Professor and Financial Planning Program Director at the Cotsakos College of Business at William Paterson University in New Jersey, and which was quoted in How to Pay Your Financial Adviser, The Wall Street Journal. December 12, 2011.