Should you switch from a commission to a fee-based retirement account? If you work with a brokerage account, your adviser may soon ask you that very question.
That’s because under the Labor Department’s new conflict-of-interest rule, which goes into effect next April, brokers are required to discuss with their clients what meets their best interests: keeping assets in a commission-based account or switching to a fee-based account, where the typical fee is 1% of assets under management or AUM.
So, what advice do experts have for investors who have to decide what’s in their own best interest?
If your assets are in a commission-based retirement account and you don’t need advice, stay with your current broker.
“If you’re generally a buy-and-hold investor, aren’t doing regular transactions, don’t need ongoing management, because the portfolio isn’t changing, and don’t want any of the other advice … you shouldn’t be in a fee-based account,” says Michael Kitces, publisher of the Nerd’s Eye View blog. “Just pay your $10-per-trade commission each time you need to make a change to the portfolio — which should be almost never — and move on.”
Others go one step further. “Does this consumer need and want professional financial advice?” asks John Olsen, president of OlsenAnnuityEducation.com. “If ‘no,’ then the question is easily resolved. Don’t pay for it. Choose only those investment and insurance products that impose no, or the lowest, fees and charges, and be your own adviser.”
Drawbacks to DIY and commission-based accounts.
“An adviser who was compensated by an initial sales commission for selling an investment or insurance product and who receives no further compensation over time may be reluctant to perform the monitoring required by the product he or she sold,” Olsen says.
Likewise, there are drawbacks to becoming a do-it-yourself investor. One, you may not have the knowledge or time to serve as your own counsel. “And two, many — perhaps most — investments and insurance products require ongoing monitoring to ensure that they’re operating to best meet the investor’s needs, which may change over time,” Olsen says.
Meanwhile, if you have a fee-based account and you need ongoing advice, stay put. “If the consumer requires ongoing advice and monitoring of her investment portfolio, a fee arrangement makes the most sense,” Olsen says.
That could be an hourly fee, annual retainer or a fee that is a percentage of AUM.
If, however, you don’t need ongoing advice, consider switching to a commission-based account, especially in the absence of value. “If your adviser isn’t providing some kind of genuine ongoing value — in the form of portfolio management, financial planning advice or some other value-add — you shouldn’t be paying an ongoing fee.”
Others agree that the decision to switch turns on value. “The value provided in an advisory relationship often extends beyond investment advice to include areas such as tax planning, family governance, risk management, retirement planning and the like,” says John Nersesian, a managing director with Nuveen Investments. “It’s important to consider the value of these services in the context of the cost.”
Doing nothing can be in your best interest. To be fair, advisers who do “nothing” can be acting in their client’s best interest. “Notably, sometimes the best trade to do really is ‘nothing,’ so the fact that an adviser is paid an ongoing AUM fee to not trade isn’t necessarily fatal,” says Kitces. “Some investors would do very well to have an adviser help them invest, not only to make changes in the portfolio but also to know when not to make changes.”
Beware reverse churning. Experts warn against switching from a commission-based to fee-based account without getting a cost-benefit analysis from the adviser.
“You should only pay your adviser for ongoing management or ongoing advice,” says Kitces. “But if you aren’t going to use an adviser for ongoing management nor ongoing advice, the adviser shouldn’t be recommending an ongoing fee relationship to do ‘nothing.’”
This, Kitces says, is the essence of “reverse churning,” a practice that regulators, including the Financial Industry Regulatory Authority (FINRA) have been scrutinizing recently. According to Kitces, reverse churning is the practice where clients who aren’t doing much of any trading anyway got shifted into ongoing wrap-fee accounts just so the adviser could get an ongoing AUM fee for doing nothing.
Personal preference. Cost-benefit analysis aside, what matters most could be the adviser and not how they are paid. “It may well be that the preference a consumer has, as to mode of compensation, is less important than being able to work with a particular adviser,” says Olsen.
Bottom line. “The key issue, regardless of fee structure, is what am I receiving for what I am paying, what is the value of professional advice,” says Nersesian. So, when deciding what’s best for you — fee-based or commission-based — consider your account size, your account activity and the types of investments you have.
And regardless of fee structure, Nersesian says investors should demand the following: transparency and objectivity, which are the key objectives of the Labor Department’s new conflict-of-interest/fiduciary rule.