Fees vs. Commissions

Jonathan Clements

I RECEIVED AN EMAIL yesterday from a broker in Texas with the subject line: “Why do you want to put good honest advisors out of business?” The broker argued that I was being unfair in favoring advisors who charge fees over brokers who charge commissions.

My response: “You’ve convinced me that you do a fine job for your clients. But there’s plenty of evidence that many advisors don’t. Their clients—to use your phrase—need to get ‘a fair shake.’ How can we improve the odds that, when an individual ignorant of the financial world walks into a broker’s office, that individual doesn’t end walking out with a fistful of inappropriate, excessively expensive products? Charging fees rather than commissions isn’t a panacea. But it does improve the odds of a happy outcome.”

The fact is, a commission-charging broker has an incentive to get clients to trade and to buy higher-commission products. Yes, there are also problems with charging fees. An advisor that’s levying, say, 1% of assets might push clients to save too much (hardly a terrible thing) or discourage them from taking money from the portfolio to pay down debt (more of a problem).

Still, paying a percentage of assets is a fundamentally better arrangement: Both the advisor and client want the same thing, which is to see the client’s portfolio grow, so the client gets richer and the advisor’s fee increases.

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