Do your clients suffer from fee blindness?

I believe the investing public has an acute case of “fee blindness.” Most of our clients have no idea how much their investments and we, their financial advisers, are costing them and they may unknowingly be putting their retirement years at risk It's not our clients' fault. The financial services industry, of which I've been a part for more than 25 years, has not done an adequate job of making investment expenses clear and understandable. On top of that, the manner in which we, the advisers, are compensated is outdated and, in my opinion, unfair to many of our clients. While the expenses for many investments have been trending down over the past 20 years, it's safe to say that most investors don't have a clear understanding of what those costs are. With too much industry jargon being used and statements that are difficult to read, it's not an easy task to make sense of these expenses — and many investors stop trying. In my opinion, a simple solution would be for the financial advisory industry to expand its efforts on investment expense clarity by requiring advisers to present an accurate, easy-to-understand analysis of what the client is actually paying on an individual basis. If an investor works with an adviser, there is an additional cost to be borne beyond the investment expense. Adviser compensation models are much more client-friendly today than when I began my career. Back in the late 1980s, advisers were largely paid by commissions — only when a transaction occurred. Unfortunately, this compensation arrangement was basically a sales transaction, and the adviser needed always to be searching for the next sale with a secondary goal of actually managing the money that clients entrusted to him or her. Popular compensation arrangements today are more of a partnership instead of a transaction. The adviser can charge an annual percentage-based fee against the client's account with no upfront or back-end commissions. If the client's account grows, they both make more money; if the portfolio loses value, the adviser makes less money. Under this arrangement, the adviser has a vested interest in monitoring the client's portfolio and making proactive recommendations. This has become a very viable adviser compensation arrangement just for this reason. However, I often wonder if it is fair for all investors. Under this “fee-based” arrangement, the adviser normally discounts the client's rate as the portfolio gets larger, thereby giving investors with larger portfolios a discount from the initial starting rate. On the surface, this sounds like it makes sense. However, it's possible these larger investors may not be getting their money's worth. While the fee rate is indeed reducing, the actual amount of money the investor is paying the adviser is still going up, with no end in sight. Why is it this way? Because it's just the way everyone does it. Financial advisers would make two arguments in favor of this compensation method: It's an incentive to continue to do a good job; the advisor has a vested interest. It takes more time and effort to manage larger portfolios. First, I would point out that any adviser's true incentive in doing a good job for his/her clients is client retention, along with the fact that, if the client is truly satisfied, said client will refer friends and family. That allows the adviser to expand his/her business further. Second, with the technology we have at our disposal today, it doesn't take that much more time to manage a $5,000,000 portfolio than it does a $500,000 account. Individual client situations can certainly pose different levels of complexity but, by and large, the time involved to manage the money is about the same. The bottom line is that this current compensation model leads to investors with larger portfolios subsidizing the costs of the investment firm to manage smaller portfolios. While alternative compensation arrangements are available, most have not gained any traction because investment firms are not interested in “giving up” the large revenue streams they are deriving from their largest clients. In my opinion, that isn't fair. A better solution is to acknowledge that there are basic fixed costs in providing investment management services and, at some point, those costs shouldn't continue to go up. Clients, especially those with larger portfolios, should benefit from that. This is why I advocate adviser compensation arrangements that are capped in some way; so the investor goes into the relationship knowing what his/her maximum outlay for the financial adviser would be. Like most financial advisers, I love what I do for a living — helping people make sound financial decisions. It's time for us to offer our clients more transparency and improve compensation arrangements in order to rid the investing world of fee blindness. It's time to do what's right. Phil Wood is president and chief executive of One Price Portfolio, a national, independent wealth management firm that specializes in managing portfolios with a capped fee. One Price Portfolio is a division of Wealth Partners Inc.