Fees vs. Commission vs. Hourly.
Each compensation system has its champions and foes. The proponents of each option treat the options as mutually exclusive and posit that their favorite method is better than the others. These assertions are incorrect, and all of these compensation methods have their merit in different circumstances. Let’s consider the different client circumstances.
Some clients buy services, some buy products. As a securities broker, you want to always form the relationship as a financial planning relationship, gathering data in an effort to know your clients and handle all of their financial affairs and provide retirement help. Some prospects would resist this process and merely want to know “What’s a good investment now?” These people view investing not as a process and not about a relationship with a professional but merely as buying a good stock or fund at the right time. Because your business is about them (and not about you)I open the relationship with such people by selling them a product, and then later make the transition to a planning relationship after you start off the way that they preferred. In other words, have you been rejecting potential relationships because the prospect did not want to do it “your way” by starting off with a retirement financial plan?
These product-oriented prospects are also commission-oriented—they think they should pay for a transaction, for the broker “doing” something. They don’t understand why they would pay an ongoing fee. They can’t understand that money is often made by doing nothing and that the planner adds value when he tells the client not to trade. (The older members of the profession probably know of Jesse Livermore, the famous trader, who posited “the money is made in the sittin’).” I know of a broker who had many of his clients sit with a $5,000 stock investment for 30 years. That investment grew to $500,000 in value and the only compensation he received was the original commission on the $5,000 trade. Clearly, the value he provided was by telling his clients year after year, “don’t trade.”
Other people are relationship-oriented and they desire ongoing and continuing advice and oversight. They don’t want to pay for trades which they believe give the broker an incentive to make or suggest transactions. Fee-based accounts suit these individuals just fine.
Now let’s consider the circumstances of the broker. New in the business, you are happy to take a $5,000 mutual fund ticket. This is a commission-based transaction. It usually takes us some time until we feel confident enough and have a sufficient book of business to raise our new account minimum to $100,000–often considered the threshold for fee-based accounts. Because established brokers often have minimums, small investors are the domain of newer brokers. Therefore, the new broker will likely fail if he decides he will have a fee-based business as the new broker is dependent, in the beginning, on many small transactions for commission. The new broker will likely have many conversations with people wanting to invest under $100,000 and both parties are likely better served by a transactional relationship for the time being.
Last, we must consider the matter of the broker’s time. The value-oriented client believes that he compensates the broker for the broker’s advice, experience and wisdom of their recommendations, and that the trade is just the incidental and mechanical implementation of that advice. Fee-based compensation is consistent with this model, as the broker gets paid for the value of the relationship, i.e., the advice, experience and wisdom. However, when a broker works on a commission basis, the broker gives away these valuable assets and gets paid for the incidental and mechanical implementation, i.e., the trade. It is foolish for the broker not to get paid for the value provided and that’s why all must charge hourly fees as soon as possible. In other words, even if you are mainly a commission-based broker, you cannot prepare plans or do any analysis without getting paid. If you do, you diminish your value permanently in the client’s eyes. So get an RIA certificate and start charging when you deliver value.
Whether your normal mode is to charge money management fees or commission, there are times when the prospect or client consumes your time. Charge them. It’s ludicrous for planners to do financial plans, invest say four to six hours and then, upon receiving the plan hear the prospect say, “I’ll think about it.” At the end of the first meeting, when you offer your advice and the client wants the benefits that a plan will provide (structure, lower taxes, higher income, higher probability of reaching financial goals, an extra vacation, a college fund for the grandchildren, etc), they must pay for it. If such planning will take six hours, the planner must say “It will take six hours of time to show you how to have these benefits. My rate is $200 an hour so if $1200 is reasonable to have the solutions to lower taxes, higher income, higher probability of reaching financial goals, an extra vacation, a college fund for the grandchildren, etc, then let’s meet again in 2 weeks to review my recommendations.”
However, to charge only hourly fees is not a good idea. You should be paid for the value you add, not the time you spend. When you charge hourly only (as do CPAs and attorneys), you are a slave of the clock. It takes 30 minutes a year to manage a portfolio that beats 80% of professional money managers (see dogsofthedow.com). If you create value, then I believe the 1% ($2500) I collect on a $250,000 account is fair compensation. Highly evolved capitalists get paid for the value they create and the key is to match how you get compensated for the value you provide.
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