Today is less about the mechanics of life insurance in the aspect of how it applies to you, but more in how it applies to us. We wanted to dive into the fee only vs. commission financial advisor model, essentially to ask the question: is there a better way? Is one way more virtuous than the other?
Does the insurance and investment industry need to change how brokers get paid?
Let’s start off discussing the fee-only model as there seems to be some confusion as to what it really means. When you hear “fee-only,” it really means they are charging you a percentage of the assets that you are putting under their care—which is basically a commission, but for some reason, we've all decided to call it a fee. It's largely a game of semantics.
Now, the fee-only crowd claims that an advisor being paid based on product sales commissions creates a dangerous incentive said advisor to oversell. But when you really look at them…how are fees that different from commissions?
Fees are typically charged quarterly, and the charges are contingent upon the client's account balance. So, the incentive is for the fee-only advisor to have more client money under their control so that they can charge you their fee on a higher balance. None of this is a bad thing mind you, not trying to demonize fees at all, just the way it works.
The incentive here is for the advisor to do a good enough job selling their clients on the idea that having more money parked here is a good thing.
Why have we accepted this as fee-only?
I think when most people someone say they’re a fee-only advisor, there's an image we all conjure up. That is that we imagine the advisor sitting down in the office with their potential clients to talk about services, and at the end of that consultation, the client writes a $2,000 check, and that’s that.
But here’s what happens—that’s typically the last conversation the advisor every has with the prospective client. Why is that? Most people are not willing to write that check for $2k. I believe this probably the purest form of financial advice on the planet, however, most people are not willing to pay the price. Why they aren't is another discussion about psychology and conditioning which is beyond the scope here.
My suspicion is that most fee-only advisors have figured out that there is a lot of friction involved in getting someone to write a check. But if they just take money from their account once a quarter without them having to do anything, it’s far easier.
The fee is on autopilot, similar to that gym membership that just keeps billed to my credit card every month.
I've looked at dozens of statements from accounts that have this sort of “fee arrangement”, and it’s often not very clear what clients are paying. What's worse is that most clients aren't very clear on what they're actually paying for. Which is interesting when the fee-only crowd boasts itself of being the model of full-disclosure. There is no separate invoice mailed out asking the client to write a check for services rendered.
We’re not suggesting that one method of compensation is better than the other, but I am suggesting that basing a discussion of good vs. bad involves a whole lot more than how the financial advisor is compensated. Some people suggest that fee-only is the only way because it removes the ugly incentives and we're disagreeing with that idea.
The real problem with Fee-Only
The problem that we encounter over and over with the fee-only model is that clients go out into the marketplace looking specifically for financial planning. In many cases, they are sitting across teh table from an advisor that has all the right financial planning credentials. The advisor calls themselves a financial planner, but the client discovers at some point in the process that this is really just an investment guy who is looking to get paid roughly 1% on assets managed.
In fact, they do very little, if any, ﬁnancial planning. There’s a discussion about assets, asset allocation, the folly of market timing etc. but not a lot of discussion on anything else. No mention of how income planning using annuities might benefit them or how their pension actually works and certainly no mention of life insurance.
The fee-only model has just become a thinly disguised financial planning ruse. It’s not immune to abuse. It’s not immune to creating incentives for the practitioner to seek out a way to create more money for them and their clients.
Is it bad?
Not absolutely. Charging a fee to manage investments is not bad, but when you call yourself a financial planner and all you’re doing is investing money for a fee…that is bad.
Since it’s evident that the fee-only model doesn’t really address financial planning well, then what do we do for financial planning? What’s the right answer?
If we’re looking at incentives, what is a person’s incentive to do the things that we’re paying them to do? If the incentive is for them to develop a good financial plan, then you should just write a check.
However, the pool of people able and willing to write a check to actually get financial planning advice is tiny. Because of that small pool, it has so far proven to be an unviable business model.
Think about this from the perspective of the advisor. If we give someone a price of $2,000 for a financial plan—which, in our opinion, is the lowest cost we would ever consider charging—it’s a low price for the amount of work being done. We have to break down every single financial aspect of your life in a fiduciary capacity and provide you the best advice possible, it’s going to take a significant amount of time. There’s a lot of intricacy to that planning.
Obviously, there’s another way to operate the insurance world, and that’s to be paid commissions. People love to vilify this as if this is the evil way.
And trust us, we would have no problem giving up all the commissions that could be paid for an insurance case by just telling the client to write a check—but I'd venture a guess that most won’t write the check.
We’re putting in twenty years of experience and expertise, so we have to be compensated fairly. It’s not just the work being done today but also the emails and phone calls a year from now—not to mention all the work and money that went into you being able to find us.
So, there’s a lot that goes into to all this. There are all the countless hours preparing very sophisticated ideas to people and never hearing from them again.
In order to make it all a viable business, there has to be compensation.
We’re not sure why, but anything that seems to be finance related is hit with this implication that we shouldn’t make that much money or that we don’t deserve to be compensated accordingly. But when you start stripping away the incentive, those highly-qualified people leave and do something else.
What about the noble calling to do this job? Well, like any other profession (doctors, lawyers, etc.), we don’t work for free. We didn’t choose this career just for the virtue, we chose it for the income. That doesn’t make us con-artists. It makes us human.
That’s the real danger of all of these talks about virtue when it comes to how people are paid. If you strip the incentive, the talent will leave. You’ll be left with people content on working for a salary where their incentive to work hard and make sure everything is done perfectly just doesn’t exist.
There will, unfortunately, be people who abuse the system (just like every other industry). But trying to cut down what we get paid to stop some jackass from taking grandma’s last $30,000 and stufﬁng it into a 20-year surrender annuity or churning it to death in the stock market isn’t going to beneﬁt the world at large.
Ultimately, the compensation models that are in place are fair, and we don’t need to change them. The fee-only title is misleading, but that’s okay. We don’t need a massive overhaul. If you want people who are going to be engaged and helpful, proper incentives must be in place.