Pet Peeves
Peeve 2 - “My Financial Planning Services Are Free”
NASD Registered Investment Representatives often offer free financial planning services and seminars. In this arrangement there is no charge for analysis, advice or preparation of a financial plan. Compensation is received solely from the sale of products purchased in order to implement financial planning recommendations. This is commonly referred to as a commission-only compensation arrangement.
How much does free financial planning cost me? The cost depends upon the product. Let's examine and compare mutual fund and variable annuity commissions on a $100,000 investment in each product.
The mutual fund prospectus explains the sales charges associated with various share classes and dollar investments. For example: “A” shares incur an initial sales charge of 3.5% on a $100,000 investment so the mutual fund company pays the Broker-Dealer $3,500. “B” and “C” shares do not have an initial sales charge but still pay the broker-dealer commissions of $4,000 and $1,000 respectively. The “C” share commission is smaller but is paid annually, not just in the first year like “A” and “B” shares.
Mutual fund commissions are easily identified. The “A” share commission is deducted from your account immediately and is itemized on your fund statement. The “B” and “C” share commissions are not deducted immediately. Those commissions are recouped from the annual fees assessed against the account and reflected in the annual expense ratio. A comparison of the “A”, “B”, and “C” share expense ratios reveals the higher internal annual costs for the “B” and “C” shares.
Variable annuity commissions are significantly higher than mutual funds, less transparent, and do not offer breakpoint discounts as the investment amount increases. This has led to improper product sales and replacements and has drawn significant regulatory scrutiny leading to numerous fines and disciplinary actions. A typical variable annuity pays a $5,000 to $7,000 sales commission. Some even pay a new commission at the end of the surrender period to prevent advisors replacing them. These costs are recouped using Contingent Deferred Sales Charges and expenses ratios that are higher than mutual fund expense ratios.
What is a fair price for advice? This obviously varies by investor based upon their investments and the complexity of their situation. It also depends on the organization and the effort the investor is willing to put forth. If the advisor is supplied with organized information and statements, and the investor thoughtfully answers a questionnaire prior to the first meeting, then a fee range of $500 to $1,500 would be reasonable depending on the complexity of the investments. A full financial plan including investment recommendation could be done for at least $1500.
Consumers have resisted paying for advice historically. Consumers are becoming more educated about costs and abuses, and the trend seems to be toward that of paying fees for advice instead of paying commissions for products. Hopefully this trend will continue. Consumers will be better served when primarily seeking advice.