Fee vs Transaction Based

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Jan 22, 2006 9:48 pm

I’m interested in learning more on the rationale for fee-based business, and more specifically ‘wrap accounts’. If a client had $300k IRA money and  a transaction based rep put him in American Funds, Franklin and Van Kampen at $100k each (say, AMCAP, New Perspective, Fundamental Investors, American Mutual, Mutual Qualified, Mutual European, Franklin Small Cap Value, Franklin Strategic Income, Franklin Income, Templeton Foreign, Van Kampen MidCap Growth, and the 3 Van Kampen Growth & Income funds), how would a 1.25% annual wrap fee be better for the client? Let’s assume he’s 60 in good health and taking a 5% distribution. The load-adjusted return on the above portfolio after 20 years would be about 20bp below nav. They are all team managed and pretty consistently favorable on returns and beta, plus the families offer other good choices without incurring additional sales charges. Some data supporting the fee based approach would be useful to me.

Jan 22, 2006 10:31 pm

in my wrap program my client also gets:

quarterly rebalancing the advisory aboard has the ability to tweak asset allocation models based on a variety of factors newsletters cost reporting statement quarterly performance reports access to quite a few leading mutual fund famililes approved thru due diligence by our adv board

and most importantly myself as their financial quarterback.    Is that worth an extra 1-1.5% annually as opposed to doing it themselves? 


Jan 22, 2006 10:43 pm

Besides the things mentioned by Scrim, it's not hard to put a hypo together using funds from several (more than three) fund families and show better performance (even with the wrap fee), better asset class representation and less overlap.

Plus, when I need to swap a fund out, there's no load charged.  If you want to ride that fund list without changes for the next twenty years, it's your choice, but if I were your clients, if that's all I was getting, I'd research some good no-loads and skip you altogether.

Jan 22, 2006 10:43 pm

Butkus, have you looked at the amount of overlap in the funds that you’ve mentioned?  I’d hesitate to call what you suggest a properly diversified portfolio.

Jan 23, 2006 1:07 am

I have a tough time asking someone to pay a load upfront.  I do solely managed money and mutual fund wrap. 

Although the fund families you mentioned are good now, they may not always be.  A wrap program allows you to be flexible without additional costs to the client.  It also puts you on the same side of the table with that client.

Ask yourself this... if you put 300k into those funds and get your upfront money, are you still going to rebalance the portfolio and meet with that client regularly 4 years from now, when that client is generating no revenue for you?  I doubt it.  And if you do, you'll be in sales mode to generate more revenue.

I firmly believe in "pay as you go."

Jan 23, 2006 7:22 am

I love variable annuities. You get a nice upfront commission, with the ability to automatically rebalance and exchange fund families, without a load, and you don't have to injure the client with an extra 1.5% fee, in perpetuity, to do it.

Jan 23, 2006 7:58 am

No, depending on the variable annuity, you get to “injure the client” with a fee much more in the ballpark of 1.75 to 2 depending on the riders you choose. 

Jan 23, 2006 8:23 am

[quote=mrad]No, depending on the variable annuity, you get to "injure the client" with a fee much more in the ballpark of 1.75 to 2 depending on the riders you choose.  [/quote]

With all due respect mrad, you should look at some other, better, annuity contracts. 

Jan 23, 2006 8:38 am


With fee based accounts, you don't limit yourself and your client to mutual funds to solve all the issues.  There are a lot more investment vehicles out there than the Preferred 8 that provide much more for clients.  One of the best points raised I agree whole heartedly with is that you as the advisor take on the consultant role providing much greater reporting and analysis with the client.  When you slam them into the cookie cutter portfolio you describe and subscribe to, you trade it and forget it.  When that's the only value added you bring to the table then you right, A share is all the works and you should only get that measly .25bps for pay (minus 60%).

Jan 23, 2006 8:40 am

I should have said - " When that’s the only value added you bring to the table then YOUR right, A SHARES are all THAT works and you should only get the measly 25bps for pay (minus 60%)."

Jan 23, 2006 9:51 am

Fee Based advisory account-

Create the appropriate allocation (growth, growth and income, and aggressive growth is not asset allocation) and select the very best fund in each asset class.  NO BIASED APPROACH.  Very simple to us, but extremely difficult to the client.  2 of the "gowth and income" funds from Van Kampen are the same fund, only one holds bonds. Anyone from Jones just doesn't understand the fee based method, you're brainwashed not to.   

Jan 23, 2006 10:38 am

[quote=csmelnix]I should have said - " When that's the only value added you bring to the table then YOUR right, A SHARES are all THAT works and you should only get the measly 25bps for pay (minus 60%)."[/quote]

No, what you should have said is "YOU'RE".  Its a contraction of "you are".

Jan 23, 2006 10:53 am

You're; I'm sorry may be I am stupid?

Jan 23, 2006 1:32 pm

I have a fairly contraversial attitude towards this question of fee v.s. commission.  before I give my 2 cents I'll say upfront that I have done mostly fee based mutual fund and SMA wrap invesments.

I am beginning to believe that charging a fee (in the range of 1 to 1.5% or more) is only appropriate where an advisor is taking an active, personal role in the management of the portfolio or financial affairs of the client (outside of just hiring and firing money managers or "automated" bill pay systems, reviews, basic finacial planning etc...).  Whether that means they are using a tactical approach to weighting the portfolio asset classes, picking individual securities or handling "value added" services akin to family office type activities.

There are several foundations I base this perspective on: 

1)  We should be paid for the value we add (which I understand can be somewhat subjective)

2)  Adding value is a result of expertise applied and services rendered

3)  If the clients had a clear understanding of what we do behind the scenes (which they don't), What would their perceptions of "fair value" be?

My experience with most wrap programs is that they are a plug 'n play product with similar amounts of expected work as an A share mutual fund.  Yet we end up getting paid more (over time), for essentially sitting on the assets, oh sure we send out birthday cards and take the customer's out for dinner, call them to talk with them about their kids and "update their financial plans"

Of all the professionals out there (attorneys, cpa's, doctors) that we are trying to identify our profession with, not one gets paid like we do for the amount of work we do (not considering the marketing aspect of our work which can be vicious). 

My stand is that if you are a securities "salesperson" (which most people selling fee based products and financial planning are) than you should be paid like a salesperson.  If you are a money manager (clear definion being: taking an active day to day role in the investment of your clients $$) You should be paid like a money manager.  If you are a true blue wholistic wealth manager (not just by title or marketing gimmick) then you should be paid like a wholistic wealth manager.

When management consultants get hired to solve a problem for a company (which I think is comparable to solving financial problems fo r clients) they get paid a one time fee.  If they have to revisit the company multiple times to track progress and oversee results, they get paid a fee for the work done, not an ongoing % (other than maybe a retainer which is different than a % fee) based on the value of the company. 

My contention is that a huge majority of the people in our business like to imagine themselves as something they truly are not and put up a convincing image to the public (it's what Wall Street is famous for).  This is why there is so much legislation dealing with our industry.

Do I have a perfect solution, no.  Do I think it's of value to have a candid and open discussion on the issues and alternatives, yes.

Jan 23, 2006 2:28 pm

dude, I understand your thoughts.  I have "sold" both concepts in my few years doing this...and relatively well (I think...).  If I was a client, I'd feel that the way in which I compensated a person was far less important than the total long term cost, and what I got for my $.  You are right that many less-than-wonderfully qualified people want to make lots of $ for dumping people into an allocation model (theirs or someone else's) and not much else.

When looking the pros and cons, I think I personally would pick a fee-based approach to hedge my bets with the advisor--what if he/she gets run over, retires, decides to become a buddhist monk, etc. before I've gotten my service out of that upfront chunk?  And maybe as importantly, I know that people pay attention when I'm paying them, so I might prefer to pay them a little each year, which adds up to more over time, to ensure they keep paying attention.  Plus all the benefits already stated about manager selection, etc.

I think the fee-only folks will continue to gain market share--I can't imagine paying A share loads if I could pay someone a flat fee to develop an allocation and go buy the funds no-load for close to $0 at Schwab or wherever.  I agree with you--if you set and forget (or don't "add value"), an hourly/flat fee approach will bury the fee-based guy.  I've somewhat tried to use the myriad of client-confusing cost approaches to my advantage, just by explaining them.  Of course, that in itself confuses some, but at least they feel like I'm trying to tell them how the game is played and that I know what I'm talking about.  As for me, I vote for fee-based as it seems "cleaner" in the long term...as someone mentioned--now a 300k retired client is someone I need to really keep in touch with vs. a somewhat revenue-dead account.  Luckily, market forces will continue to evolve to tell which is "better."

One random thought--how come mutual funds get to always be "fee based"?  It doesn't cost twice as much to manage my $100,000 as my $50,000, so how come they take 2x out of the fund's assets?!

Jan 23, 2006 2:38 pm


Your last comment strikes at the heart of my concerns.  It doesn't take any more work for me to manage $500k vs $100k, yet I get paid 4 to 5 times as much.  Am I getting paid for adding value, when I'm not really managing the money?  As far as the fee based model for money managers, I tend to think that their compensation being tied to the account value is a good thing, although a tiered system of declining fee as assets go up is probably most appropriate.  I think this (a tiered fee system) would be difficult (if not impossible) for a mutual fund to do.

Jan 23, 2006 2:45 pm

OK, I guess I was saying “me too” w/regard to funds/money mgrs–if they can charge it, then I can too.  We have a workable compromise–I can live with a tiered scale being “right”, and most fee-based platforms do scale down, but usually at pretty large accounts it seems ($1m+).  I think the main problem with fee-based is not the concept, but the level of fees…paying 1.25% on top of mf seems crazy…I think 100bps should be the absolute top, but until people get educated enough to realize what they really pay, fees will still be higher than they “should” or could be.  Again, I say this is a way to differentiate–explain all the fees and then keep yours below market for protetction when they do get squeezed.  ETFs can help keep the total pretty reasonable.  NOW, go debate me on the training vs. product thread where I tried to stir you up as well…

Jan 23, 2006 2:59 pm

This whole issue is quite the slippery slope, no?

If I always found the least expensive route for my clients I would have to drop out of this profession.    I've asked this before, "What is a financial advisor worth?"   

In the long term our clients will be the ones to tell us if our services are worth it.


Jan 23, 2006 3:02 pm

As far as arguments that commission makes an advisors advice biased, I say B.S.

If a client of mine has A shares and wants to  buy property and asks my advise: No great harm to me since .25 bps is a relatively small hit to my income, if it makes sense I tell him to do it.

Now, if I'm fee based, I'm much more BIASED to advising the client to keep his $$$ with me.

I'm not saying that fee based is a bad model.  Just the way it has been marketed and implemented.  The vast majority of fee based Wrap programs I have seen are plug 'n play static (stragtegic is the marketing hype) allocations.  I also believe that the "manager oversight" that an advisor supposedly offers is another marketing gimmick that generallly offers little value. 

Here's what's really funny about the whole thing is that the science supporting ibbottson (and most allocation model approaches) is that the markets are efficient (markowitz's theory is based on the efficient market hypothosis), therefore indicating that it's impossible to add value through security selection.  In addition the Brinson and Associates study (92% of returns come from allocation 6% from security selection and 2% timing) is used to support this approach and yet the advisor puts forth that he/she is adding value through managing managers (a.k.a. "security selection") or tactical allocation (a.k.a. "market timing").  What gets me thinking is that one has to use conflicting and contradictory market attitudes to sell the product.

So in essence it seems that if one believes in the foundations that make up Modern Portfolio Theory, they are having two faces to say that they are adding value through security selection, or market timing (a.k.a manager selection, tacticall allocation).  If the science one uses supports the concepts of Efficient Market Hypothosis, how can you then use active managment (mutual funds, money managers etc..) to populate the asset classes without being hippocritical?  Also all of the "standard features" of wrap programs: auto rebalancing, performance reporting etc.... are usually "automatic" and done by the back office, is this really adding value?

Jan 23, 2006 3:35 pm


Fee based advice used to be primarily offered through independent registered investment advisors many of whom are classic indexer's MPT guys.  The bear market opened the wirehouses eyes that there is a more predictable level of growth, hence the move toward fee based accounts predictable revenue streams etc.

As far as active/passive ETF's and index funds don't offer revenue sharing or marketing support for seminars and the like.  You do the math...