As Jim says, "Not every blog post can be earth shattering and life changing." I'm pretty sure none of our blog posts skew as either of those but I've been wanting to put this info on our website for some time now. It just takes time and concentration. I’ve had time lately due to our COVID-19 pandemic. The concentration part has been more elusive. Entrè—trying to work from home. Emphasis on the trying. If I explain this well, I will have clarified how we get paid and not confused you. If I get it wrong, I preemptively apologize. There are so many moving pieces and entities involved.
For independent advisors, I think most of us are transparent about our fees and how we get paid. But in the captive world, it’s still opaque. I’d mention some names here but it might portend that I have an axe to grind. And truly, I don’t. Not today at least. One look at some statements and it looks like clients pay nothing for the investment products they have bought. Please believe me when I tell you that this is never true.
As a parent, I loathe using superlatives. I tell my kids, “Never, ever, and always commit you to being wrong.” Sometimes they listen. Sometimes they double down and say, “But it’s true! He always gets his way!”
Back to the part about never true.
It’s never true that a client pays zero, zilch, nada for an investment. If they can’t find how much it costs, most likely the cost is built-in or charged in such a way that it is hard to see it. I’ll go over this later.
When you take the cost to invest and add it to biases regarding talking about money, it may feel inappropriate to ask a financial advisor how they get paid—let alone, how much do you get paid?
Our view on this is, if you are paying us for advice or buying a product that generates a commission, you should know how much we are paid and by whom.
In our space, as an independent financial planning and investment management business, there are 2 types of what we call business fee models. One is RIA or fee-only and the other is hybrid.
RIA stands for Registered Investment Advisor and those advisors and firms are registered directly with the SEC, the Securities and Exchange Commission, or individual states—it depends on the amount of money they manage. These advisors hold a Series 66 license or a Series 63 and Series 65. For more detailed info, read this article. Their revenue generation is called fee-based only. They charge a fee for assets under management or assets under advisement. The client pays this fee based on a percentage of the assets (e.g. money) invested. They advise their clients on how to invest the money and execute the actual investment transactions (buying and selling of investment products). These advisors do not sell commission generating products or manage commission generating accounts.
The second is a hybrid model. These businesses and advisors are dually registered with the SEC and FINRA. FINRA, or the Financial Industry Regulatory Authority, is an additional regulatory organization. The licenses these advisors hold can vary, but typically it is a combination of a Series 7 and 66, or a Series 7 plus a Series 63 and 65. In addition, they usually have a Life Insurance License. Their revenue generation is fee-based (paid by the client) and commissions (paid by the carrier).
We fall under the hybrid model. Like an RIA, we charge a percentage fee for assets under management and we sell products that generate commissions and manage accounts that generate commissions. The fees plus commissions is the hybrid model.
To go into a little more detail about how we make our money, I’m going to flesh out our services below. We have 3 distinct services we offer.
1. Financial Planning Fee
Since this is our main focus, we charge a flat yearly retainer for financial planning. This requires a Series 66 or a Series 63 and Series 65. Financial planning is a separate set of skills and it brings a holistic and much more time-intensive planning into the process. Currently, the annual fee is based on complexity and comprehensiveness of the planning process. The retainer fee is anywhere from $1,200 to $7,500 per year. We bill this fee either monthly or as a one-time charge. It is renewed every year.
2. Investment Management via Fee-based Accounts
These kinds of accounts are charged a percentage of the dollar amount invested in the account. This service is solely for investment management. This requires a Series 66 license or a Series 63 and Series 65. Jim holds a Series 66. To charge for this, we have a tiered fee scheduled. You can see it here.
With a fee-based account, there are two costs. There is the cost of the actual investments and the fee we charge. For the cost of the investments, we use third-party money managers (TPMMs). Jim explains the role of third-party money managers here. The other option we could have chosen is having Jim research, choose, and trade (buy and sell) all the investments inside the account, along with rebalancing on a quarterly or semi-annual schedule.
Jim does not like building portfolios and picking individual stocks or bonds. It’s really time-intensive and something he feels is better left to the financial analysts that do this all day, every day. He does provide this service, but the minimum requirement is $1,000,000. Using third-party money managers frees him up to spend more time with clients and focus on what he does best, which is advise and implement financial plans.
These TPMMs charge what we call a platform fee to use their services. This is paid directly to them out of the account and none of this is paid to us. It is deducted prior to crediting any investment gains. So, if the account (without any deposits) grew by 6% in one year, and the platform fee was 25 basis points (or 0.25%), then the account grew by 6.25%. This will not be line-itemed on statements. The first time Jim explained this to me, it blew my mind. I was flabbergasted. I felt everyone should know what I deemed highly secretive and misleading information. Then, once I was in this industry for a bit, I started thinking, “Duh! They’ve got to make money somehow. They aren’t non-profits.” For me, I still think this should be line-itemed on statements instead of buried in book-length mutual fund prospectuses that no one reads.
The great thing about this type of account is that is puts us in the same boat with our client. If the account value increases, both of us make more money. When the account value declines, we also make less money. There is a built-in vested interest for us and our RIA to choose well-vetted TPMMs.
Investment Management Fee
For the fee that we charge, we do not retain 100% of that fee. Since we are a hybrid firm, we have an RIA and an OSJ (Office of Supervisory Jurisdiction, which is a person who holds a Series 24 license) that oversees all our transactions. If you’re a client, you’ll get correspondence from our RIA regularly. Jim is an Investment Advisor Representative (IAR) under our RIA, United Planners Financial Services. Are you tired of the acronyms yet? I apologize—again. For their oversight, they take a haircut of our fee. If their current percentage was 12%, for a client who paid $1,200 in investment management fees in one year, $1,056 goes to us and $144 is split between our RIA and OSJ.
Another great feature about these kinds of accounts is that the total fee includes all trading costs. No matter how many trades are made, the fee is a percentage.
3. Commission Products and Accounts
Lastly, we sell products that generate commissions and manage money inside commission generating accounts. This requires a Series 7 and a Life Insurance License. This is where the hybrid part comes in and differentiates our business model from the RIA or fee-only model.
The dollar-amounts for commissions vary on the type of product. Examples of these commissionable products are life insurance, disability insurance, long-term care insurance, most annuities, and brokerage commission accounts.
For example, when a client buys a term life insurance policy through us, and the best carrier for that policy is Principal Life, then Principal Life pays us a commission. The client would never know how much we are paid unless we tell them. It is built into the cost of the premiums they pay over the life of the policy. Typically, term life insurance pays 70-100% of the first year’s premiums and that’s it for the life of the policy.
A second example is brokerage commission accounts. Say this account held only A-share mutual funds. We are paid an upfront commission in Year 1 on initial deposits and then trail commissions in subsequent years. For example, on a $200 monthly deposit, say the upfront commission for the 1 mutual fund invested in is 5%. We get paid $10 for the first year of that initial deposit and the remaining $190 is invested. In the subsequent years, we are paid trail commissions on the total amount in the mutual fund. Say there is a total of $20,000 invested, and the fund pays 10 bps (basis points) or 0.1% in trail commissions. On that $20,000 account, we get paid $20 per year.
RIA firms only manage fee-based accounts. Inside those accounts several investments can be held—from mutual funds, ETFs (exchange traded funds), individual stocks, bonds, to alternative products like REITs. These same investments can be held in a commission account instead of a fee-based account. We have quite a few accounts like this. These accounts are not regularly traded. Typically, their holdings stay the same for long periods of time. The reason is that the 5% upfront commission makes it cost prohibitive to do a lot of trading in and out investments. We suggest these accounts if the product warrants it or clients do not want active management.
Active vs. Passive Management
Our thoughts on active versus passive management are that everyone loves passive on the way up and hates it on the way down. In extremely volatile markets, we highly recommend active management. Even in less volatile markets, our bias is toward active management because it is extremely difficult to time the market.
On Choosing a Hybrid Business
Why did we choose a hybrid business over an RIA? When clients need commission-only products, we know we can advise them well. Some products are only available via commission, like life and disability insurance, plus most annuities and alternative products. These products aren’t for everyone, all the time, but if a client’s situation warrants these, we want to provide access to that product and the subsequent service in the future.
One last note: some RIA firms and fee-only advisors tend to hold themselves out as having no conflicts of interest because they don’t get paid commissions. But are they paid? Yes. It’s only the by whom that differs. I don’t agree with this no-conflicts assertion and neither does Jim. I firmly believe that anytime money exchanges hands there is an inherent conflict of interest. I can’t be convinced otherwise. Here is the reason: humans! Humans are fallible. They like to do things in their own best interest.
There’s only two things you can do with a conflict of interest. You can disclose it or mitigate it. But you can NEVER eliminate it. That's my 2nd superlative in this post. I’ll count that as having hit my acronym and superlative limit for the day. If you have any questions about what kind of accounts you have, whether you’re a client or not, feel free to reach out to us at email@example.com. Cheers to demystifying how we independent financial planners get paid.
* Cover photo by Bud Helisson on Unsplash