134 Fees Are Better than Commissions

I'm sure that the title of today's financial procast will cause some of you to wonder if we've just completely lost it. Well, there's certainly an argument for that, however, we just figured that we would agree with all the people out there that actually believe that statement.

It's true…fees are better than commissions.

At least for the people who charge fees it's better. 

It turns out that the SEC is sort of going nuts on the whole wrap account situation. But perhaps we should explain what exactly a wrap account is.

That can be easier said than done.

What is a Wrap Account?

Wrap accounts come in a variety of flavors–there are unified managed accounts, managed accounts, mutual fund wrap accounts etc. The basic premise is that you (the investor) have a pot of money and you engage a financial adviser to manage your money and/or accounts. In turn, the adviser will charge you a fee that “wraps” around your entire balance that he/she has control of under the agreement.

The fee will be based on an annual percentage, typically between 1%-3% is what we've seen most commonly. Billing of the fee occurs quarterly in arrears and is usually one-quarter of the annual percentage based on the aggregate account balance on the last day of the quarter. Oh yeah…the fee is deducted from your account(s).

In exchange for that fee, you get financial advice, investment management and trade execution to carry out the strategy that you've agreed upon. Generally speaking, when a person chooses to have their assets in a wrap account, they will incur additional trading costs, brokerage commissions or load fees from mutual funds.

In other words, the whole point behind wrap accounts is that you will avoid paying load fees and commissions. The value added service is that you and your adviser will now have an alignment of values because they are not incentivized to sell you one product versus another to make more money. Now, they are seated on the same side of the table as you and together you can work to plot a strategy that makes sense.

It's a really compelling fairy tale.

Not to say that there aren't many financial advisers who work exactly that way

Does a Wrap Account Make Sense?

Wrap accounts hurt account growth over timeThe whole concept of a wrap account is wildly unsuitable if you don't plan to have a relatively high instance of trading or transactions that would cause you to otherwise pay a lot of money in trading or transaction costs.

But let's be clear about something here.

All of the reasons that the investment industry gives as to why a person should use a wrap account is a consumer-facing sales pitch at best.

The pitch to advisers (from their firms) as to why they should get more of their clients into wrap accounts is entirely different. We don't want anyone to be under some false pretense that there has been some great meeting of the minds and that all of these firms (and their advisors) have become so altruistic that they've decided making money should take a backseat to providing increased value to their clients.

It seems to us that many people in the financial services industry hold out wrap accounts as the best possible option for someone who wants to save money AND use the services of a financial advisor. We all know that paying commissions is terrible (if you could only see the sarcasm light flashing) so instead you should pay a fee and that's not a commission so that's better.

Now if we ask “Why?” we don't seem to get a lot of really clear answers but there are just a number of people out there who believe that wrap accounts are a superior method because it's cheaper, better or something.


2 Responses to “134 Fees Are Better than Commissions”

  1. Steve Stanganelli says:

    A very compelling and thoughtful post per usual.

    I will say that the difference between a commission and a fee may be more than semantics. Commissions are paid to agents who have a duty to an employer or other affiliated organization. A fee is the compensation that is paid to a fiduciary who has a duty to the client. At least that’s my understanding of the difference from speaking with others with sharper legal minds than mine.

    I personally do not get into the holier-than-thou fee versus commission thing. Just wanted to point out this perspective.

    On the substantive matter about the cost of the wrap account, I will say that it may make sense for clients who are seeking more active advice especially in certain areas of the market. That being said, I don’t use wrap accounts. I’m like many of my other IRA peers. We prefer to build out portfolios with low-cost ETFs. I do trade some positions. So the custodial fee cost certainly makes sense (0.20% per year for all trading and record-keeping). Coupled with the typical overall cost of the ETF portfolios (usually under 0.4% per year) and my cost (usually <0.80%).

    This seems comparable but more transparent than the average cost of an actively-managed mutual fund (though it is still less than such a fund). And this may be similar to the M&E charge for an insurance product. I don't think that there's any altruism here just the reality that advice-based services need to be compensated from whatever the source as long as the client understands what they are getting.

    Sure, an individual investor could disintermediate the role of either an insurer or an investment manager by doing it themselves. But in reality, most consumers lack the time or interest. And if they're like my typical clients, they're asking questions about everything else – and investing is just tangential to the conversation.

    With the reality of 'robo-advisors' out there charging 0.25% to 0.5% for an algorithm-based asset allocation, I believe that the bulk of an advisor's fee is really for the advice not necessarily the investment management.

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