People respond to incentives. Few incentives carry the power the profit motive does-usually, in my view, that's a force for good. But it can also cause some to act in a means they might otherwise not be inclined to. Your broker may be the nicest person in the world, but the commission-based or fee-and-commission-based model has inherent flaws that calcify conflicts of interest. In my view, a broker with noble intentions is effectively swimming upstream-and against a strong current. This conflict of interest is inherent in how the retail brokerage industry is built; how it commences relationships; how it peddles products; and how it compensates its workers. Finally, that conflict can be seen in how many in the industry judge the success of individual advisors. For your consideration, I've collected a few of many potential examples to illustrate below.
In a nutshell, commission-based advisors are paid to trade. They are faced with putting your financial best interests against their own as they weigh investment recommendations.
--Six Signs That You Should Fire Your Broker, Kelly Campbell, Forbes
Most planners, his report finds, reinforce our bad investment behaviors instead of fixing them. And the problem, he says, may be harder to solve than the fee issue.
There is a need to get business in the door and have that client come back year after year ... So they will avoid the difficult conversations.
--Financial Advice: The Yes-Man Problem, Stephen Gandel, CNNMoney
Some firms call themselves "fee-based" to describe (or euphemize) a hybrid of trading and sales commissions with AUM [assets under management] fees. It's a model most often used by brokers or advisers who are affiliated with a B-D [broker-dealer].
Commissions are the economic equivalent of a "sugar high" for wealth managers in that the near term cash flow may generate an immediate rush of pleasure but the long-term negative impact on valuation is likely to leave you feeling irritable.
--The Good, the Bad and the Ugly of Revenue, Ben Robins and Steve Cortez, Financial Advisor Magazine
Coinciding with a recovery in the commercial real estate market, the result is that 2013 has been a record year for nontraded REIT sales. Industry executives believe that registered representatives and advisers will sell $18 billion in nontraded REITs this year, almost double the amount the industry sold last year.
--Non-Traded REIT Managers Have Little Skin in the Game, Bruce Kelly, InvestmentNews
But critics of nontraded REITs say there are a number of troubling features about the trusts, including high upfront fees that lower the value of the investment by as much as 17 cents on the dollar. Sales commissions and fees are typically 9 to 10 percent, and there are also charges for leasing, management and acquisition of commercial buildings.
--A Closer, and Skeptical, Look at Nontraded REITs, Terry Pristin, The New York Times
[Variable annuity] net assets reached an "all-time high" of $1.61 trillion...
--Annuity Sales Down in Q1, But VA Assets At All-Time High: IRI, Danielle Andrus, ThinkAdvisor
But can you guess who loves variable annuities? Folks who earn sizzling commissions selling them. A 7-8% commission split with a firm still yields a tidy 3-4% commission for the seller. That's $7,500-$10,000 on a $250,000 annuity - often with very little time or effort.
--9 Reasons You Need to Avoid Variable Annuities, Eve Kaplan, CFP., Forbes
Along with those high commissions and cool product features, however, also came high fees and steep penalties for investors who wanted to get out of their variable annuity (VA) contracts before periods as long as seven years. Products became hard to sell so the industry began offering inducements to get consumers to keep buying and funding those high commissions and management fees. The main carrots here were performance guarantees and minimum payout promises, and the promises escalated into an arms race between competing insurers.
Low interest rates make it very hard for insurance companies to lock in decent yields on safe investments and nearly guaranteed that many of their payment promises on variable annuities would turn into money-losing propositions. Some of the best-known companies in the industry were forced to run away from their VA businesses and even cut their losses by trying to buy out contracts with those costly performance guarantees.
--Why It's Time for Variable Annuities to Change, Philip Moeller, US News and World Report
What to make of all this? A broker or advisor is facing a series of conflicts of interest-and compensation is the primary one. How an advisor gets paid may not always result directly in their recommendations to you. But the institutionalized pressure in the field does lean in that direction. Many in the industry even celebrate efforts that could be seen as highlighting exactly this:
The [advisor's] ranking reflects the volume of assets overseen by the advisors and their teams , revenues generated for the firms and the quality of the advisors' practices. [Emphasis is mine.]
--Top 100 Independent Wealth Advisors, Barron's
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.