Commisions, Fees and why it matters

My Dear Reader,

A point of contention when discussing anything related to sales is typically centered on commissions. In fact, some companies are built on advertising no commissions. Littered all over billboards and television sets are advertisements, particularly in the automotive industry, that claim that they don’t pay commissions to their salesmen. This stems from the belief that salesmen care only about the commission earned by the product. Because each product offers a different percent as a commission, it’s understandable why this is a dangerous proposition. When ‘our money and financial future are on the line, we would want to think of our advisor as being impartial, not a salesman. This is one reason I have such a problem with universal life policies. however, even knowing this fact, I still believe that every advisor and financial professional ought to be paid by the company itself.

We’ve touched on fees inside mutual funds, but they are not exclusive to those products. Fees are, over time, one of the greatest detriments to the American public’s wealth. This brings in a few concepts that we’ve discussed earlier in this book, such as compound interest, opportunity cost, and capital. In a private anonymous study, online investment firm Personal Capital found that “At the lowest average advisory fees (0.82 percent) and lowest total fees could cost an investor with a $500,000 could cost an investor an average of $502,407 over 30 years.”18 What they are saying is that over time, as fees are paid year over year, their impact on the account they service can be dire. Fees take from the investors’ hands, and if that money is going to be used to retire on, it can eliminate vast amounts of wealth before the government even touches it. Writer Johnathan Todd says it this way: “The impact of fees is twofold: An investor pays an ever-increasing amount in fees as account balances grow, because the fees are based on a percentage of assets. And fees also strike a blow to the portfolio’s returns. That’s because every dollar taken out to cover management costs is one less dollar left to invest in the portfolio to compound and grow. So, in addition to paying potentially hundreds of thousands of dollars in avoidable fees, our research shows that an investor gives up many times that amount in lost portfolio returns over time.” This is because fees are paid by us, not the company itself, so that money could have been invested, instead of funding the advisor’s lifestyle.

Another great illustration comes from an article titled “The Tyranny of Compounding Costs.” Although the issue was related to mutual funds and the fees within them, the disparity between what the client could have had and what they ended up with is telling. The story starts with benefits expert Brooks Hamilton disputing the claims of John Bogle, who founded the vanguard Group. The article displays the table on the next page:

“The table breaks down Bogle’s example of the impact of compounding and compounding costs over the long term. On the le it shows the growth on $1,000 invested by an individual at age 20 until his or her death at age 85, assuming 8% annual growth. On the right, it shows what happens to that same $1,000 assuming a 2.5% annual cost, such as a mutual fund management fee. Over 65 years, these annual fees eat up a staggering 79% of what the investor would have earned with no management fees.”

This issue causes us to examine exactly how products are recommended. Conventional wisdom would tell us that the commissioned salesman is just trying to sell us a product for the money, while a fee-based advisor is impartial, and simply doing what is right for us. There was an unconfirmed story of President Barack Obama in 2014 telling the head of one of the life insurance lobby groups, “I don’t believe that you can make an impartial  recommendation while earning a commission.” This sentiment is repeated over and over in magazines and in the media. Recently in Forbes, an article was published that claimed the difference between fees and commissions was:

“Basically, you can divide advisors into two types: commission-based and fee-only. The commission people sell you investment products, like stocks and mutual funds, and get paid for it—that is, they get a commission. The fee-only advisors don’t sell you anything but recommend an asset allocation that you put into effect. They get paid either by a share of your assets or by flat fees.”

I believe this is an oversimplification of a wider problem, which is the stigmatization of commission based financial products. We can look at all the numbers and debate which is better, but it makes it all the more difficult when we realize that there are victims everywhere. It’s not the advisor’s fault either, it’s simply the mechanisms of money at play.

To your creation and potential,

Kevin Prendiville