Tag Archives: how your broker gets paid

12b-1 fees: what they are

April 25, 2016 By in 12b-1 fees, Getting financial advice, How your broker gets paid, securities markets Tags: , , , , Leave a comment

fiduciary

The recent Labor Department determination that all financial advisors making recommendations for individuals’ retirement savings must act as fiduciaries is reviving interest in the topic of mutual fund/ETF fees and expenses.

Being a fiduciary means that the advisor has to place the client’s interest ahead of his own.  It isn’t permissible, for example, for a fiduciary to recommend an investment that is likely to return 5% per year, for selling which he gets a large commission, over a virtually identical one that will return 8%, but which pays a small commission.  For a non-fiduciary, which is what brokers/financial planners are when dealing with non-retirement assets, pushing the low return/high commission alternative is still ok legally.

Personally, I don’t like it that the fiduciary standard doesn’t apply to non-retirement investments.  I also don’t understand why individual investors don’t appear to be worked up about this.  I do understand why the big banks are opposed to fiduciariness, since applying the fiduciary standard to all advice to individuals strikes at the heart of the profits of the traditional “full service” brokerage industry.

12b-1 fees

The 12b-1 part refers to the section of the Investment Company Act of 1940 that governs how an open end mutual fund is allowed to pay for fund distribution and servicing.  It covers things like advertising, sending materials to prospective shareholders or having a call center to answer questions about the fund.

The general idea is that a fund benefits from retaining existing shareholders and adding new ones, so it’s a legitimate use of shareholder money to promote both objectives.

But the most common use of funds under the 12b-1 rule–and the least well understood, in my view–is periodic payments to financial advisors by a fund while clients continue to hold shares.   In the industry, these payments are called “trailing commissions,” or “trailers.”

The SEC doesn’t limit the amount of this fee, although FINRA (the Financial Industry Regulatory Authority, the investment industry trade group) rules set an effective  cap of 1.0% of fund assets yearly.  My sense is that the most common fee percentage for an equity fund is 0.25% – 0.50%.  The best hard data I can find come from the ICI (Investment Company Institute, a mutual fund trade group), and are from 2003.  At that time, aggregate 12b-1 fees amounted to just under half the total administrative expenses, at 0.43% of assets annually.  The rest were old-fashioned (more clearly understood by customers) sales charges.

why is 12b-1 a current issue?

Historically, disclosure of these fees has been exactly crystal clear.  Try finding information about them on the ICI website, if you don’t believe me.  In fact, I can’t recall having met anyone not involved in selling mutual funds who was aware these fees exist.

So, does a broker/financial planner who advises a client on retirement investments in mutual funds have to make sure the customer understands that 12b-1 fees are being subtracted from NAV on a regular basis?  Once he gets that, does the customer put two and two together and realize he’s subject to these fees on non-retirement investments, too–and has been from day one?

How does he react?

The difficulty I’ve experienced in gathering factual data for this post tells me that fund companies think the reaction will be strongly negative.

 

Wall Street firms are running out of retail brokers

June 27, 2014 By in Getting financial advice, How your broker gets paid, Investment firms, mutual fund holders and financial advisors, Where are the customers' yachts? Tags: , , , , , , , Leave a comment

In the post-recession world, traditional brokerage/investment banking firms have become much more interested in the steady income that can come from providing financial advice to individuals.  This is partly due to the demise of proprietary trading, partly a new respect for recurring income.   But Wall Street is finding it hard to maintain its retail sales forces.

One would think that with the Baby Boom beginning to retire, and having 401ks and IRAs rather than traditional pensions to support them in their “golden” years, there would be a lot of demand from this quarter for professional investment advice.  Yet, brokerage firms are finding it hard to recruit salesmen.  The demographics of the big (or “full service,” as they’re called) brokerage forces themselves are also telling:  lots of over-fifties, few under-thirties.  Why is this?

In general:

1.  The internet has replaced financial services as the destination of choice for ambitious college graduates.

2.  Brokerage firms have traditionally been hostile toward women, thereby eliminating half the possible job candidates.

3.  Being a financial adviser is–something I kind of get, but kind of don’t–a relatively low status position, down there with used car salesman.

Specifically:

4.  People under the age of, say, fifty (maybe it’s sixty, though) would prefer to deal with a discount broker over the internet than face-to-face with a traditional brokerage salesman.  I have no short answer as to why, but they do–even when introduced to an honest, competent broker by their parents.  Of course, maybe that in itself is the kiss of death.

5.  Traditional brokerage firms have decimated their research departments as cost-cutting measures during the recession.  This eliminates the only reason I personally would consider a traditional broker.

6.  A broker typically gets a little less than half of the commission revenue he generates (see my post on how your broker gets paid for more detail).  The rest goes to the firm, which uses part of that to pay for offices, recordkeeping, and marketing…   For many years, however, firms like Fidelity, Charles Schwab or other, more low-profile companies have been willing to provide established brokers with back-office support for a small fraction of that amount.  I’m not current on today’s arrangements, but while I was working a broker could easily increase his “net” commission from 45% to 80% by switching to one of these firms.  Yes, he might have to provide his own office, but the headline is that he could increase his income by 78% with the move.

 

What’s new about this situation isn’t that it’s happening–this has been going on for well over a decade–but that traditional brokers are finally concerned.   Their retail business model is broken, however, and I don’t see it getting fixed any time soon.  My question is how Baby Boomers are going to get the financial advice they need to manager their money during retirement.