Financial advisers who cut their commissions when the market turned down shot themselves in the foot, according to a new study from PriceMetrix, a firm that provides practice management software to 15,000 retail wealth managers.
The firm's latest study looked at 7 million equity trades executed for transactional accounts over a three-year period ended in June 2011. It found that commissioned brokers who cut their fees didn't retain more clients than those who did not offer discounts. Those who cut fees also had difficulty raising rates when the markets improved.
“Sympathy pricing is a psychological issue,” said PriceMetrix chief executive Doug Trott. “We think a lot of reps feel guilty when the value of their clients' positions goes down. But lowering [commission] rates doesn't help them keep more clients or attract more business.”
In fact, the data show that advisers who raised their prices over the past three years had stronger growth in production than those who didn't. The ones who raised rates saw only a 6% decrease in the number of households they advise, versus a 9% decrease for advisers who kept their fees lower. PriceMetrix does not have the ability to correlate client attrition rates with adviser performance.
The PriceMetrix data indicate that commissions on equity transactions dropped from about 62% of the scheduled rates of brokers' firms in June 2008 to just over 57% in the fall of 2009. Price levels slowly recovered by the beginning of this year, but again have begun to decline.
“Clients leave their advisers because their expectations aren't being met not because of prices,” Mr. Trott said. “A fair and consistent pricing strategy is an indication of the quality of a rep.”
According to the study, advisers discount about-two thirds of the trades they execute for clients to the tune of about 35% from their firm's scheduled price. That leaves an average of $132 per trade on the table.
Part of the problem is firms' archaic commission schedules, which Mr. Trott said are still largely based on
New York Stock Exchange schedules in place before commissions were deregulated in the mid-1970s. “Reps think they are illogical and difficult to defend to clients, so often they ignore them,” Mr. Trott said. “A lot of the pricing is done on the fly but rarely involves a negotiation. Many advisers just charge a round number that they feel they can defend to clients.”
The
Financial Industry Regulatory Authority Inc. has proposed a rule that may make the exercise easier for brokers. The proposal, which closed to public comments in March, would require broker-dealer firms to disclose their commission schedules to clients at least once a year. Mr. Trott said it's going to be very difficult for firms to explain, let alone justify their rates, and they are likely to simplify the schedules.
That still leaves brokers to determine if they'll offer discounts in difficult markets. One practice that Mr. Trott said brokers should abandon is giving the little guy a break. The data show that households with less than $50,000 in assets actually got an average 32% discount on trades versus a 28% discount for households that have between $50,000 and $1 million. “We see it all the time because reps may think the little guy deserves a break,” he said. “If you're going to take on a household, charge the full price and don't subsidize the small investors.”
PriceMetrix offers a software product that lets brokers see what other reps are charging for the same trade. Mr. Trott thinks that having that knowledge shouldn't lead brokers to discount transactions but rather give them confidence to charge a fair and consistent price.
“Investor demand for advice is not price elastic. Brokers have to train their clients that pricing doesn't depend on what happens in the market,” said Mr. Trott. “They need to develop a simple schedule that they and their clients can understand and stick to it.”
