Why Pay Financial Advisor Fees to Someone Who Acts As a Middleman?

Paying financial advisor fees is paying twice for the same service. It doesn’t make sense in practice, but most people don’t realize what they are paying for in the first place.

Skip the financial advisor middleman and invest directly

Skip the financial advisor middleman and invest directly

Key terms for new investors

FiduciaryUnder securities’ law, if a financial advisor is paid an ongoing financial advisor fee for investment advice, he is deemed a fiduciary and has to act in the best interest of the retirement investor. A typical fee is a percent of assets under management (AUM), ranging from 1.00–2.50% for traditional services. However, most financial advisors divert their fiduciary responsibility through legal loopholes and don’t deserve your payment.

Most investors assume their brokers are already governed by a fiduciary standard. According to a Cerulli Associates study, 63% of investors working with wire houses or regional broker-dealers believe their advisors are governed solely by the fiduciary standard. Advisors in this channel report that only 13% of their clients had fiduciary-only relationships. The lesson here: Don’t assume your advisor is your fiduciary.

Portfolio ManagementA portfolio is a collection of investments that can comprise any mix of stocks, bonds and cash. A portfolio manager is a fiduciary* and chooses the investments for the portfolio and manages the portfolio or fund on your behalf.

Non-discretionary portfolio managementThis is the advice given by financial advisors about which investments to make for your portfolio. The final decision is yours, however, not the financial advisor who is “advising” you. Even though you are paying an ongoing fee for investment advice, there is a legal loophole that exempts the advisor from fiduciary status, which means the advisor can act in the best interest of their firm, not yours.

Discretionary portfolio managementThis is when a portfolio manager chooses the investments and monitors them on a daily basis, such as with a mutual fund. The discretionary portfolio manager can buy and sell the investments without consulting with you. The portfolio manager is a true fiduciary.

A mutual fund company’s fiduciary duty is to put the interest of the shareholder first, as specified in the Investment Company Act of 1940, according to the Securities and Exchange Commission** (SEC).

Paying Ongoing Financial Advisor Fees is Paying Twice For The Same Service

Contracts are structured so that financial advisors are not held responsible as a fiduciary (read the fine print in your contract). This means the retirement investor pays:

  • The financial advisor an ongoing AUM-based fee (typically 1.00–2.50% annually) to a middleman that has no fiduciary responsibility, and
  • The portfolio manager investment fee, who is the fiduciary, to actually manage your money

Recall, a fiduciary monitors investments on your behalf on a daily basis. A portfolio manager is responsible for their investment decisions and is monitored by the state and federal agencies they must register with. A mutual fund portfolio manager in a discretionary portfolio management role theoretically puts your interests first and is contractually responsible for the ongoing monitoring of your retirement savings.

You are paying twice for the same service because the portfolio manger must be paid for his time, knowledge and decision-making skill whether you use a financial advisor or not. So why pay twice?

* Source: U. S. Department of Labor:  Advisory Opinion December 4, 2009: http://www.dol.gov/ebsa/regs/aos/ao2009-04a.html
** Source: Securities and Exchange Commission Investor Bulletin on Hedge Funds, October 12, 2012: http://www.sec.gov/answers/hedge.htm

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