As Published in Fortune Magazine on 8/20/2014 by our Managing Partner, Michael Neft.

Fee-based accounts have been with us for a long time. Since their introduction in the mid-80s, fee-based accounts have received both criticism and praise. As a FINRA Arbitrator for more than 22 years, our Managing Partner Mike Neft has seen many examples of fees charged to brokerage accounts. Usually, they are appropriate, but others can be completely unjustified, and sometimes even downright egregious.

If you are a trader or generate numerous transactions in your account, a flat fee-based account may make a great deal of sense in lieu of your paying individual commissions per each trade.

Another sensible example of having a fee-based account is in hiring a professional money manager, since often the fee charged reflects the cost for hiring this person in the first place. The broker may also add his hiring fee onto this type of account, which is also acceptable if the fees are not too excessive.

Your broker or financial advisor may offer you a fee-based mutual fund account. which makes sense if you need the help and direction to manage your account with an entire portfolio of mutual funds. In this situation, however, the fees may be high ¬– and there can be some serious hidden dangers, including the fact that a fee-based account doesn’t insure against loss in a market correction.

In our experience, we have met with people who are about to retire or are already in retirement, and often we find that they are invested in some type of fee-based account where the invested portfolios are risky, including unsuitable stocks and/or mutual funds.

We have also met many individuals with significant portfolios who are paying fees in excess of 2% annually and are completely at risk if the market underperforms or crashes. The justification given is that their portfolios are diversified and allocations are made frequently. However, the reality is that when someone retires, a more conservative approach should be taken, and fees and risk should be constantly addressed and consistently justified.

We are seeing more and more abuses with fee-based accounts. Accounts that are supposed to be fixed-income accounts are not. Individuals who need an income to live on and who cannot afford to take any risks are unknowingly 100% invested in mutual funds requiring them to pay high fees.

What’s even worse, and increasingly unethical, is that while many clients rely on that income to live on, their portfolio contains fixed-income mutual funds, also known as bond funds. which pay them less income each year than they are paying in annual fees. When interest rates begin to go up, the funds’ value could decline.

An example we see frequently is the client with a $500k portfolio being charged $12,500 annually, while this person’s account has generated only $6,000 in total income – less than half of what he or she is paying in fees.

Another common scenario is someone with a bond portfolio who is charged a fee between 2% and 2.5%, a rate that is higher than the interest rate on a majority of the bonds in this person’s portfolio. While this action is not illegal, it is highly unethical. A bond is meant to be an income-producing vehicle used to pay a certain interest return for a designated period of time. At bond maturity, the client receives his money.

However, when the portfolio is static, meaning the advisor researched the bonds, purchased them for a good reason, and earned a commission initially, there is no reason to charge an annual fee any longer. Why would you pay your advisor an annual fee when he or she is doing nothing more than mailing the interest checks once they’re received? To charge a fee for managing a portfolio of bonds, when all that the client needs are his mailed interest checks, is incredibly difficult to justify.

To put this matter into perspective, with interest rates at current levels, a portfolio that is yielding 2.5% and being charged a 1% fee has an overall net return of 1.5%. There is no reason to pay a fee for this so-called “service.”

Finally, the worst possible situation we see is this: A prospect is charged a fee for all of the assets in an account, even if a large portion of the money is in a money market account. Once again, this is not illegal, but it is exceedingly unethical.

The bottom line is that while fee-based accounts can make sense in some specific instances, you should always be aware of the abuses that often occur with them. After all, it’s your hard-earned money.

As Published in Fortune Magazine on 8/20/2014 by our Managing Partner, Michael Neft.