Everyone is Different (and Better!): Part 4

Overall costs of service.  Investment costs present some interesting issues.  Various distribution channels have traditionally used different disclosure methods.  Because of these differences, many consumers had little idea of the fees they paid.  Often, options that seemed low-cost were quite the opposite.  There’s a sign in our conference room reminding clients that:

“The cheese is always free in a mousetrap.”

On some levels, fees might seem unimportant.  One very smart attorney explained this to me in football terms: who would you rather have as quarterback of your favorite team, a star like Joe Montana or some lesser-rated journeyman?  Obviously, most of us assume that Joe Montana in his prime was worth a lot of extra money.  You always pay for what you get, my attorney friend argued.  It’s an interesting point, but, again, flawed. 

Investing isn’t very much like football.  There’s an abundance of research suggesting that investment managers operate with much less skill than quality quarterbacks.  That’s not saying they’re worthless, just that active management adds less value than you’d think to most portfolios.  In the main, a major component of performance comes from general market movement, not the portfolio manager.  So why pay huge expenses? 

Timing also plays a role in the perception of fees.  High fees are simply more tolerable in period where markets are quickly rising.  No one complains about a one percent (1%) fee when the market gives their portfolio a twenty percent (20%) boost!  Ask again after the market is down by twenty percent (20%) and see how they feel.  (A good advisor may genuinely earn one or more percent in a down market by reducing risks and protecting against a sharper correction.)

Of course, there are some parts of the investment world where expertise plays a key role.  Smaller sectors – say, developing markets or very new companies – aren’t covered as broadly by the general press or analysts.  Managers specializing in these fields may incur higher costs and reasonably pass them along to investors.  Yet, how do we decide what deserves higher fees and what doesn’t?

The Schwab Center for Investment Research did an extensive study of mutual fund performance (June 1999, Vol. II, Issue I).  They ran computer analysis on dozens of factors that might contribute to mutual fund performance.  Two primary factors emerged with strong correlation – lower costs and recent performance.  Good performers tend to repeat (sadly, so do bad one) and, since costs necessarily reduce performance, lower fees mean higher returns.  They didn’t specifically test this on other non-fund asset classes, but experience tells me that it’s true.

Investment fees are changing across the board.  The Internet and other resources have created a very transparent environment.  Fees are no longer hidden, and savvy consumers can easily locate helpful information regarding costs and value provided in exchange for those costs.  Trading and other costs have fallen (and keep falling) while convenience and ease of use keep going up.  It’s a terrific environment for do-it-yourselfers.  Providers that can’t measure up in this environment won’t survive.

Environmental changes spur different kinds of investment services and fee schemes.  From all this, some casual observers are predicting the demise of investment professionals.  I’m very skeptical (as you’d expect).  Oh, there’s no question that our industry is changing and that some professionals will not survive.  As with any era of rapid change, traditional methods often implode, just as new methods thrive.  It’s a natural progression.  Survivors simply adopt new and better ways to serve their customers. 

I’ve already observed one radical new behavior among investment consumers.  The freedom to do something – virtually anything – includes the freedom not to do something as well.  Consider the routine or mundane tasks often delegated to others: lawn service, oil changes, laundry, maybe housecleaning.  Cooking (at least some portion of family cooking) slipped into this category decades ago when low cost and convenience slammed the restaurant world.

True, today’s consumer faces some wonderful new opportunities in investing.  But, easy as it has become, it still takes time, concentration, and energy to invest wisely.  It’s a fine diversion for some people (a hobby, perhaps), but it’s not for everyone.  Is investment management where you really want to spend your time, concentration, and energy?

Many smart, talented, and extremely successful people are deciding not.  I’m talking with more and more people who are actively deciding to delegate part of the investment management function to outside professionals.  They want to stay involved to some degree but not at an activity level necessary by themselves.

It’s never been easier or cheaper to delegate.  The same tools that lower costs for consumers also lower costs for advisors.  The same technology that brings quality research to the home desktop also brings it to professionals.  Good advisors provide more value and cost less than ever before.  Across most areas of our lives, it’s more affordable than ever to hire outside help.  It’s true around the house and it’s true around the portfolio.  Technology creates better value.

The truthful answer about which options are best lies with the client.  Each client brings a unique set of needs.  Some clients need a lot of safety and convenience; others need considerable expertise or reduced costs for active trading.  Chances are very good that the same firm can’t serve both clients equally well.  You have to understand the issue to reach wise choices. 

 

 

Excerpt taken from Million Dollar Management: Simple Lessons to Use Wealth Management Principles for Your Family Investments by Dan Danford (with Gary Myers), 2002

15 Years of Fee Transparency

How much are you paying on your 401(k)?  A poll conducted by AARP concluded that 71% believed that they paid no fees for their 401(k).  In reality, all 401(k) plans have some fee structure set up.  Because the amount of fees paid will impact your nest egg over time, every individual investor should be aware of the fees he or she is paying.  An article recently published by MSN Money called "Is your 401k ripping you off?" further explains the affects of fees in employer plans. 

It is important to understand the many different levels and types of fees as well.  There may be portfolio management fees, transaction fees, commissions, mutual fund expenses, loads, or other types of expenses "built into" accounts.  Regardless of the account type, MAKE SURE you know what fees you are paying and seek to reduce those costs.

Positive change: three innovative investment ideas

By Dan Danford, Principal/CEO, Family Investment Center

● $100 million of insurance per account. Banks usually offer $250,000 of FDIC insurance, and brokers $500,000 of SIPC.

● No sales or transaction fees. None.

● The world’s top experts in stocks, bonds, and mutual funds. World-wide investment luminaries like Bill Gross, usually at reduced fee.

One academic study explored the pace of change within a community. As I recall, researchers carefully documented how long it took farmers in a particular region to switch to a wholly-superior hybrid seed corn.

The pattern of change became famous. A small group of progressive farmers adopted new corn almost immediately. Typically, others were more cautious and waited a few years. At the study’s end, a few stubborn hold-outs were still planting the old corn even though the new was safer, widely-accepted, and proven through years of production.

That pattern is typical among consumers of all kinds. It’s true of technology, automobiles, and even new medicines. A few innovators jump right in, and almost everyone else pulls the old “wait and see.” A few people never try anything new.

Family Investment Center started in 1998. We brought some innovative ideas to our marketplace, and some successful groups and families joined us almost immediately. Since then, many other clients have adopted our unique approach to investing. Our largest single portfolio today is over $15 million.

Instead of being a more-traditional “seller” of investments, we are an expert “buyer” for each client. We seek quality investments, tailored to each client’s need, at a wholesale or institutional price. We select securities and investments from thousands of choices and dozens of fund families and firms. Virtually unlimited investment choice.

Today, we steward nearly a $100 million and our clientele has grown from early adopters to mainstream institutions and families. We serve several dozen nonprofit groups along with hundreds of successful families. Almost all those portfolios transferred here from other (traditional) institutions.

Our professional fees are based on the work and responsibilities involved. We work like an independent consulting firm or law practice. There are no hidden fees or commissions, and we have no financial relationships with outside firms. Essentially, clients pay us because we can help them accomplish more.

I’d welcome an opportunity to discuss our services with you. I think we can help you save substantially on fees while increasing the quality of your investment portfolios.

Things Your Wall Street Broker Doesn't Want You To Know

This video, presented by Alexander Efros of Athelon Wealth Management, discusses "7 Things Your Wall Street Broker Doesn't Want You To Know." As a commission-free investment advisory firm, we at Family Investment Center like his message and agree with his conclusions.



Most investment professionals work as sellers, representing specific investment firms or products. They earn sales commissions or transaction fees directly related to their success at selling. Good for their companies, but maybe not so good for their customers. Things are very different at Family Investment Center. We earn our fees by representing clients. We work as a buyer for each client family, matching low-cost and productive investments to their circumstances and goals. Our commission-free platform values expertise and experience above sales ability.

Danford book helps families

Dan Danford started Family Investment Center in 1998 to help families manage existing investments and grow financially independent. The firm currently serves over 150 key client families along with companies, retirement plans, and nonprofit groups. Family Investment Center is a commission-free Registered Investment Advisor stewarding almost $100 million. Danford was interviewed in his St. Joseph office.

Why write a book? Surely there are enough investment books in the marketplace.
True. But there’s a big story not generally told to consumers. I’m still astounded to encounter people who think of investing as a big game of chance. In truth, there’s solid science to investing, and I think it’s time for families to know about it. Instead, it’s often been limited to wealthy people and large foundations.

Why hasn’t this story been told to consumers before now?
It’s a function of the investment distribution system. Smaller investors – the typical family – buy investments through retail stockbrokers, insurance agents, banks, and fund salespeople. These channels focus on selling, and selling doesn’t allow much time for good consumer education.

Still, there’s no shortage of investment information.
Just look at the consumer press, though. I mean really look at the headlines and magazine covers. They simply mirror things that consumers already think. They’re selling buggy whips to horse owners. No one bothers to mention that Henry Ford created the automobile. Many financial salespeople do the exactly same thing.

Surely you’re not comparing yourselves to Henry Ford.
Of course not. We simply report the excellent work of others. Believe it or not, there’s a very large body of research about wealth management. Our book suggests over a dozen titles for further reading. Many, many, many people have contributed to the field and we’re not even part of that development. But I have taught investment classes in the business department at our university and I’ve spent nearly three decades managing money for wealthy people and groups.

Why Million Dollar Management? Many readers don’t have a million dollars.
And many financial professionals don’t manage a million dollars, either. That’s part of the point. Our sub-title is “Simple Lessons to Use Wealth Management Principles for Your Family Investments.” Many of these principles were originally discovered while studying and building large investment portfolios. But they work just fine with smaller accounts, too. That’s the first message of our book – families will enjoy more financial success if they manage resources in the same way as savvy millionaires.

What’s a good example of a difference between millionaires and the rest of us?
Dan Did you know that only one percent of millionaires trade stocks on a daily basis? Another one percent trade on a weekly basis. When Tom Stanley and William Danko wrote The Millionaire Next Door [1996, Longstreet Press] they found that fully 42 percent of interviewed millionaires hadn’t made a single trade in their portfolio during the prior year! Is that what you’d conclude after reading most personal finance magazines? I don’t think so.

Okay, you’ve made that point. Are there other messages in your book?
We think a lot about the morality of money. The notion that money is a responsibility and those of us blessed with having it should exercise sound judgment in its care and maintenance. We highlight some practical and religious family stewardship issues.

You’re beginning to sound like a prudent bank trust officer. How much has prior banking experience influenced your investment thinking?
A lot. I learned some terrific things during fifteen years as a trust officer. The best things we’ve carried over into Family Investment Center.

What’s something important that you learned?
For the typical investment professional, sales skills are critical for success. Brokers making huge money aren’t necessarily those knowing the most about investing or providing the highest return to clients. Instead, these are usually people with strong social skills and a powerful ability to persuade.

You sound as though this isn’t a good thing.
It isn’t necessarily a bad thing. But it can be a bad thing. Remember, this is a sales environment. These people are usually paid by sales commission. An ability to persuade can be a dangerous thing when coupled with high sales commissions.

So you dislike brokers. That’s what you learned?
That’s not right at all! There are some brokers I like a lot and some with very high ethical standards. But I intensely dislike any commission system. It places a salesperson’s need above the client’s. A few good people rise above this structure, but I can’t think of a single argument why sales commissions are good for the consumer. They were designed to help the company.

Yet, it is a salary system which has endured, even prospered, for decades.
Of course it is. These firms used to have a monopoly on market information. You had to use a broker to invest because there wasn’t any other choice. Charles Schwab and the Internet changed all that for the better.

How?
Now anyone wanting information can find it. The Internet combined with 24-hour news coverage has virtually eliminated any information advantage, so that reason for using a broker has diminished. And, thanks to Charles Schwab, you don’t have to use a high-priced intermediary anymore to place stock or bond trades. Today, full-service brokerage firms look like dinosaurs. Banks aren’t much better. I’ve got a glass jar in my office that is full of matchbooks from now-extinct local banks. Why do you think they’re merging like mad and trying so hard to enter other financial businesses? Consumers simply don’t understand competitive pressures taking place in the financial services industry.

If not traditional brokerage firms or banks, then what? What is the future for consumer investment services?
Well, I can’t be sure. We believe that “commission-free” investment services are a clear improvement. Commission-free professionals earn fees directly from clients and avoid commission-based investments. Working directly for the client frees them to make quality recommendations without real or perceived conflicts of interest.

That sounds much better. Why isn’t it the industry benchmark today?
It is growing quickly and some major firms are trying to transition to fees. One sad truth is that client fees are often less lucrative for the professional. Fees can be a great tool for both the client and professional, but you’ve got to have some volume to earn a living. Many brokers, insurance agents, bank investment officers, and fund salespeople can’t gather enough investment assets to survive. So, they stick with more rewarding commissioned products.

What about you? Your firm has used this fee-only model since inception. Does it work?
It works great. We are truly independent – not related to any bank, brokerage firm, or insurance company ¬ and revenues come directly from providing client service. We please clients or we die. Just like my grandfather’s grocery store back in the 1930s. Having said that, though, it hasn’t always been easy. Things change very slowly in the Midwest and we compete against some very talented traditional marketers. And, of course, over half of our existence has been during the worst bear markets ever. But, we’ve built enough volume to survive and we’re gaining a reputation that allowed us to grow during a pretty tough period. All things considered, it been a pretty good run. No complaints at all from me.

To purchase the book, click here.

Tips for Surviving Spouses

The Circumstance: Often, a surviving spouse is faced with daunting financial decisions at a time of maximum vulnerability. A survivor sometimes receives large life insurance payments, legal settlements, retirement benefits, and money from other sources.

The Danger: Unfortunately, some individuals and firms market to these vulnerabilities with carefully devised presentations and strategies. Some boast bogus expertise or empty promises. Products are often very expensive, inappropriate for the individual, and inflexible for future years.

The Culprit: A commission schedule is the culprit. Most financial products are distributed through expensive sales channels. A commissioned broker, insurance agent, or financial planner earns high sales commissions for marketing annuities, mutual funds, or IRA rollover accounts. Since survivors often control large pools of money, a crafty sales organization can create hefty profits. Many do.

The Solution: Take away the sales commissions and you take away the problem. At Family Investment Center, we offer:

• Genuine compassion for grieving survivors
• No product sales
• Honest advice on the full spectrum of investments
• Honest expertise gained through decades of investment, trust, and life experience
• Genuine credentials earned through higher education, national trade organizations, and government regulation
• Fair and reasonable prices for professional services rendered
• Commission-free (“fee-only”) investment management services (if desired)

The Price: Free initial consultation. Registration, organization, and clerical services are available for an hourly fee. Investment management services are provided for an annual percentage of account value. Special projects quoted on a case-by-case basis.

Dan Danford joins NAPFA

Dan Danford, Founder and Chief Executive Officer of Family Investment Center, was recently accepted to the National Association of Personal Financial Advisors (NAPFA). NAPFA is the nation's leading organization for commission-free advisors, focused on delivering unbiased, client-centered advice. Click here to read the announcement.

Aligning incentives between advisor and client

By Dan Danford, Principal/Chief Executive Officer, Family Investment Center

When I bought my last car, I faced a dilemma. At a critical point, I discovered that I liked the car a lot, but not the dealership. I had to choose: give up the car, or buy from a dealer I didn’t like.

Other people face the opposite problem. They like a particular dealership but aren’t happy with available brand names or models. They’d prefer a different car, but they want to buy it through their chosen dealer.

With cars, maybe you rely on a salesperson to answer technical questions, arrange test-drives, and help with the financing. You trust them to help you reach the right decision, sign necessary papers, and – hopefully – you go home happy.

What if you learned afterward that the salesperson earned special “incentives” all along the way? That the car you bought paid higher sales commissions (and cost more) than others? That your lender awarded paid vacation to sellers closing the most “deals?” Ultimately, you may have overpaid for the car and missed better financing opportunities. Would this upset you?

One solution might be a car “supermarket” – featuring multiple product lines through one dealer. You could get any vehicle you want through the same local dealership. Salespeople would be salaried, or at least they’d disclose how they are paid on every car. Then, you could reach truly informed decisions.

The compensation system is the problem. Behavior is often motivated by the way people are paid. Today, dealers sell the models they’re allowed (limited by the manufacturer) and salespeople sell easy options or those offering greater personal reward. For the consumer, it’s a dangerous system.

Family Investment Center exists to avoid similar problems in the investment industry. We don’t earn sales commissions or transaction fees. We help clients choose between thousands of investment options (no captive funds); there’s no financial incentive to recommend one choice over another. Our financial rewards are tied directly to long-term customer satisfaction.

No apologies: we eliminate pain for our clients

By Dan Danford, Founder and CEO of Family Investment Center

You’ll hear no apologies from me.

I’m extremely proud of what we do for our clients. We bring experience, expertise, objectivity, and compassion to each client. They don’t always see (or appreciate) everything we do for them, but that’s okay. Much like physicians, we can stop it from hurting, even if our clients don’t understand all the intricacies of modern medicine.

In its simplest form, that’s precisely what we do. We stop it from hurting. Worried about retirement? I’ll show how to pay for it. Worried about sending children or grandchildren to college? I know the best ways to save and pay for education. Worried about the high costs of long-term care or medical expenses? I have some helpful ideas about those, too.

Are you sleepless because your investment portfolio is too volatile? I can minimize risks without losing solid investment performance. Bothered by a lack of diversification? We know how to fix that.

Are you concerned that you might be paying too much for investment services and/or advice? We have extensive research about fund expenses and costs, including sales loads and distribution fees. In fact, we track over 27,000 different mutual funds or share classes and a wide variety of other common investments. We absolutely know what things cost.

Truly, the most valuable service we provide is comfort; that is, the ability to quit worrying and fussing with finance and investments. As fiduciaries, we have a legal obligation to work for each client’s best interest. Decisions we reach for and with clients reduce their decision-making burden.

Sometimes people arrive at our door with a history of painful investment relationships. These people are understandably skittish about accepting our help. But the skittishness evaporates when they realize that we are working exclusively for them. Our commission-free posture puts their interest first, and it’s both unique and welcome in the marketplace.

That may seem simple, but it’s not small. People today are inundated with noise. It comes from a variety of sources and features a lot of contradictory data. Much of it comes with a distinct point of view that may or may not suit their situation. Since we work with hundreds of clients with varied ailments and circumstances, we sort through this distracting clutter.

Could folks research and implement healthy solutions by themselves? Sure. But even after considerable study, they can’t bring our experience, expertise, and knowledge of diverse situations to bear on an issue. We do things for them that they simply can’t duplicate on their own.

As advisors, part of our challenge is structural. What we do is both very simple - and at the very same time - quite complex. Clients can easily see the simple things while the subtleties often hide in distant shadows. Sometimes the most critical issues (risks, costs, performance claims) are hardest to see. Distant benefits might seem hazy.

This clouded view is enhanced by the media. Most personal finance writers support the notion that investors should “go it alone.” And I’ll concur that most people are capable of basic investment and finance decisions. But that’s similar to suggesting that I should change the oil in my cars. That’s inconvenient for me, potentially hazardous, lengthier (including trips to the car parts store and a place to recycle used oil), and – ultimately – more expensive. Pain. Pain. Pain. Pain. Why would I choose to change my own oil?

Truthfully, people I talk with simply don’t want to do it themselves. When that’s the case, the only relevant issue is how to find a competent advisor who offers both comfort and value. If we can answer those two needs, our clients and our firm will prosper. It’s a healthy, beneficial relationship for both.

And, modestly, we provide highly skilled services for an exceptionally reasonable price. Comparatively speaking, we charge very little for professional services. Attorneys? They charge hundreds of dollars per hour, and up to thirty percent of a settlement or awarded damages. Architects? They usually bill fifteen percent of a project’s total cost. Realtors®? A normal commission is six or seven percent of a property’s selling price. Our modest investment fees pale by comparison.

Professional insight adds tangible value. Specialized knowledge about IRA withdrawal strategies might save $20,000 in taxes, or add $50,000 in tax-deferred growth. Is a few hundred (or even a few thousand) dollars a fair price for that reserve of knowledge? Think how much suffering that much money might save thirty years down the road. Similar examples abound.

That’s it. We eliminate pain for a fair and reasonable price. A big part of our job is to know about products, fees, strategies, and options in the marketplace. Routine tools and skills we employ are analgesics for our client’s pain. We ease decision-making and simplify life. We’re worth every penny.

Registered Investment Advisors keep clients' interests at heart

By Dr. Jason White
Family Investment Center

The world of investing and managing money can be confusing, frustrating, thrilling and gratifying all at the same time. Some folks have the financial acumen to manage their own portfolios and do quite well, while many flounder in a sea of millions of investment choices and scores of different account types and other arcane rules of the road.

If you have the time, talent and dispassionate experience needed to manage your own money, then this week’s column may not be for you, and that is just fine. The United States capital markets benefit greatly from the liquidity generated by a large number of self-interested investors. But, if you have ever considered handing off the keys to your investments portfolio to a professional, or if you have done so already, then read on.

Essentially, there are two breeds of investment advisors to choose from: Commission earning brokers who charge based on the investment products they sell, and those who work on a flat fee or “commission-free” basis, Registered Investment Advisors. Given today’s increasingly complex and intertwined financial marketplace, some traditional commissioned brokers have begun offering some types of fee-based, straddling the line between both. Yet there is a very important distinction between commissioned brokers and fee-based advisors. In legalese, it is the standard of care provided.

TAKE NOTE – A Key Point Follows

Commission-free Registered Investment Advisors (RIAs) are fiduciaries for their clients. This means that an RIA is legally and ethically bound to provide client investment services that are solely in the “best interest interest of the client.” Further commission-free (a.k.a. fee-only) RIAs must be completely transparant and disclose all fees paid by clients, by research or mutual fund companies, or any others ancillary charges – including.

Commissioned brokers are held to a much lower standard of care – the investments they recommend for customers must simply meet a “suitability” standard. Whether the recommended investment is in the best interest of the client is immaterial in the world of commissioned investment salespeople.

I have been both a commissioned broker and a commission-free (fee-only) advisor in my 20-years at the virtual intersection of the streets of Main and Wall. I will remain a passionate promoter of the commission-free RIA business model until or unless a better investment business model is developed that protects clients better than an RIA, or that is more transparent.

I’m not holding my breath waiting for this to occur.

You see, a fee-only RIA earns larger fee income from a client as that client becomes more and more wealthy. Thus, it is squarely in the best interests of both the client and the commission-free advisor to be invested in such a way as to maximize growth, income and safety over time. Clients and their advisors sleep better at night knowing that they are both on the same team. This is truly one of the best win-win scenarios available in today’s financial marketplace.

Dad's Divorce: How to find a financial planner

In this week's edition of Money Made Easy on Dad's Divorce.com, host Dan Danford answers this question from a viewer: I'm considering hiring a financial planner to help me with my finances and meet my life-long financial goals, but I have no idea where to start or who to choose. What are the right questions I need to ask when choosing a financial planner?

Danford, MBA, CRSP of Family Investment Center, lets you know what to look for when searching for a financial planner and how you should know if a planner is a good fit for you.

Sales commissions are bad for consumers

By Dan Danford, MBA, CRSP

Here’s the disclaimer. I hate sales commissions. Not just in the investment industry, but everywhere. I understand that they are a fact of life in certain trades or businesses, and that they aren’t going away anytime soon.

And I also understand why they exist. In its simplest form, a sales commission is capitalism at its purest. Employees who sell the most are rewarded the most.

I’m one of the strongest capitalists you’ll ever meet. I like business and I love entrepreneurs. I’ve started two companies myself, and I serve on the local Chamber of Commerce Board. I earned an MBA and I’m a champion for small business owners everywhere. I like employers and I absolutely love productive employees.

Take a group of employees and assign them widgets to sell. Each widget sells for $10, and each salesperson keeps $1 for each widget sold. At week’s end, the person selling the most gets paid the most.

It’s a simple system, and it works really well for the company. Besides rewarding the most productive employees, it also limits the boss’s salary expense. No sold widgets equals no salary. Similarly, when times are fat, everyone makes money. Who could argue with that?

Well, I can, and I will. None of those arguments work for the consumer. In a lot of ways, sales commissions are actually bad for consumers.

- They align the salesperson’s financial success above the customer’s.
- They add costs to the product. Without the commission, that widget would sell for $9.
- They reward employees primarily for their persuasion skills and charm.
- It’s true that they only get paid when a buyer decides to buy, but that doesn’t mean that the buyer necessarily reached an informed decision. In fact, most of us know that the exact opposite it true in many cases.

In a perfect world, buyers would research a product ahead of time, know exactly what they need, and discover a fair and reasonable price to pay. There would be no need for a costly “information middleman.”

Does anyone buy a new car today without Internet research? We know the accessories, manufacturer's suggested retail price, dealer’s invoice, and even the auto’s safety and other ratings from respected third parties. For a used car, we can easily access the car’s accident and repair history. Truthfully, most of what the salesperson does is accompany us on a test drive and add $1,000 to the price.

The same thing is true with mutual funds and insurance policies. Anyone can look up Morningstar fund ratings or get Internet price quotes. It’s true that a professional can add experience and judgment – even valuable experience and judgment – but throwing a sales commission into the pot can ruin the stew.

Morningstar tracks some 25,000 different mutual funds or share classes. Some feature commissions to salespeople and others don’t. If your investment advisor (agent, broker, representative, or consultant) gets paid through sales commission, then they’ll only be showing you some subset of what’s available. And that subset, however large or small, features higher fees to pay those commissions.

Don’t misunderstand me. I think most investors need professional help. I’m not against hiring a bona fide advisor to help create and monitor an investment plan. What I’m against is paying that person through the sale of certain products or services. Especially if other products and services might to a better job for a lower price. That’s the hidden hazard with most sales commissions.

Information we receive shouldn’t be distorted by the salary scheme. Is the Chevrolet salesperson ever going to tell you that a Ford truck is better value? When you last visited the Verizon wireless store, did they volunteer that Sprint might offer better value for your usage and region? When was the last time a paid salesperson told you “no, that’s not the right product for you.” Wouldn’t we be happier if they did?

Like I said, I hate sales commissions. They are good for the company and bad for the customer. Warren Buffett famously advised, “Never ask a barber if you need a haircut.” Never, never, never, ask a commissioned salesperson what they recommend.

Financial planning fees explained

On Mondays, we post questions from our readers, followed by an answer from Dan Danford. Feel free to post your own questions in our comments or @ reply to us on Twitter @family_finances.

QUESTION: I need some financial help and I understand the need to shop around. I read some articles about choosing an advisor, but I’m very confused about fees. How do you compare fees from one advisor to another? How important is that?

ANSWER: Since you asked, I’m going to share my best thinking on the subject. This will take a few minutes, but the subject requires some explanation and depth. I started Family Investment Center as an alternative to conventional fee structures, so I’ve given this subject a lot of thought.
And it is important. The investment world is extremely competitive. There is a stockbroker on almost every corner. There is a bank - with a discount broker in the lobby and a trust department upstairs - at almost every major intersection. Add in insurance agents and financial planners, and it all begins to run together with alarming sameness.
But it’s not really the same.

Some consumers focus on fees because it seems an easy (and important) thing to compare. If you are so inclined, you can visit a number of potential managers and collect their published fee schedule. You’d need to collect schedules from banks, brokers, investment advisors, financial planners, and (in some cases) insurance agents. By studying these documents, you’d probably arrive at a pyramid of fees.
This would be a great approach except for one thing. All options aren’t equal. We aren’t talking about a loaf of bread here, or two dealers offering identical cars. Instead, we are considering a field where there are thousands of products, and widely varying degrees of professional competence. We’re also working in the realm of horrendously complex cost structures amid an ocean of hidden fees.
Take that bank trust department, for instance. Fees shown on their schedule might omit profits they earn from their own family of mutual funds. It’s also likely that very small print discloses other administrative fees earned from outside mutual funds. They probably get income from clients plus income from selected investment options.

This isn’t illegal or necessarily unethical, but it helps disguise the total fees you pay. Looking at the published fee schedule, it’s unlikely that you’ll come away with a helpful understanding of total costs.
Similarly, just try to decipher the fees you’ll pay in an insurance product or brokerage account. It seems so simple, but I guarantee that you’ll go nuts trying to find a “bottom line” on these costs. Trying to compare costs within one industry is hard enough, across industries (insurance versus banking, for instance) is nearly impossible! It takes a carefully trained eye.
Second, and this is very important, all these options aren’t equal anyway. Since when does a broker equal an insurance agent equal a bank? Doesn’t quality of products or management mean anything?
Are all stockbrokers equal? Does the newest broker, fresh from a 12-week training course, offer similar value as the experienced professional in the corner office? Which offers better value, a fifteen-year insurance agent or a brand new trust officer? If you’re getting ready to invest $100,000, which should you trust more?

There’s a fair chance that the bank’s trust officer never passed a securities examination (trust departments are specifically exempted from the routine exams required of brokers, insurance professionals, and investment advisors). In fact, a discount broker in the bank’s lobby (where licenses are required) is potentially better tested than the trust investment officer! Does that affect your view of their investment advice?
None of this discussion is meant to slander good professionals working in the investment arena. However, it does reveal some difficulty in evaluating investment services, especially on the sole basis of fees.

It’s important to realize that I created Family Investment Center after spending 15 years in the trust/investment industry. I specialized in employee benefits and large IRAs, which offered unique insight into investment services and fees. You could say that I developed some expertise about industry costs and fees.
Here are some important lessons that I learned.
Commissions distort investment advice. They lead investment salespeople to recommend one option over others that might do a better job or cost less. In fact, the sales commission alone virtually assures that a product costs more than other options in the marketplace.
I often hear professionals say that they aren’t personally influenced by sales commissions. Consider this: Would brokerage firms, insurance companies, or banks (experts in generating income) use them if they didn’t work? Come on.
Similarly, “in-house” investments (banks or brokers offering their own mutual funds, for example) create a related distortion. The need for profits compels the organization to favor these over other choices. Of course, there’s also a built-in (and largely hidden) fee for consumers. Some groups offer a fee “discount” if you choose their products or funds – more illusion than reality.
Note also that in-house options rarely match performance offered through outside funds and managers. This may seem a small point, but it’s not. If a firm recommends inferior mutual funds, then they are – in essence – placing organizational profit motives above client needs.
Hidden fees are higher fees. I once reviewed a company pension plan offered through a national trade group. My client insisted that it was free. Buried deep in the fine print, dozens of pages into the plan prospectus, I found a disclosure of nine different charges taken against the account. Nine different and expensive fees!
In most of the investment business, sales skills are more important than investment skills. In a commissioned environment, survival requires sales. Products offered in this environment cater to consumer whims, not investment quality.

Admittedly, I consider investment fees from a different perspective than most consumers. That’s unavoidable since I have professional knowledge and experience in evaluating costs and fees. With the prior explanations as background, here’s why I’m glad you asked about fees:
Family Investment Center was created using a very simple concept. No hidden fees. Clients know right up front how much they’ll pay for our service. They know we provide honest evaluation, unbiased research, and friendly, local service. We scan the universe for quality managers and we don’t sell any “house” funds or investments.
In fact, we employ a variety of methods to control total investment costs. We charge fair and reasonable fees for the services we provide. In fact, total fees are actually lower than most other options in the marketplace.
We aren’t unique. There are hundreds of advisory firms nationwide operating in a “fee-only” environment. I prefer the term commission-Free because it’s a better description of what we do and how we operate. Again, there are hundreds of us.

Take away the commissions, and false expertise disappears, too. Education, skills, experience, and knowledge are where significant value is added.
The crucial point is that it takes judgment, skill, and experience to properly engage this knowledge for your benefit. Of thirty similar mutual funds, which one (or ones) is the best choice for your situation? Which one (or ones) fit best with other securities to meld a quality-diversified portfolio? Which one (or ones) offers the best tax efficiency for a family in your circumstances?
You may be able to find a cheaper alternative (or something that looks cheaper). Just like you can find a cheaper lawyer or a low-cost doctor. Truth is, every lawyer belongs to the bar association and every doctor holds a medical license. Chances are good, though, that you’ll look beyond price in choosing the right one for your situation. Cost, while a factor, isn’t the only factor.
Fees are only part of the picture. You have to consider everything else to arrive at value. Commission-free investing offers top value for most families. That’s why I love to talk about fees.