Today, a new generation of brokerageaccounts is available to investors. Thisnew type of account differs from the traditionalbrokerage account in 1 important way:the investor doesn't pay commissions on individualtransactions. (Yes, you read that correctly.)Instead of paying a commission, theinvestor pays a quarterly fee based onthe size of the account.
This quarterly fee covers all the servicesrendered by the broker and theirfirm—including commissions, custodialservices, and, when applicable, portfoliomanagement. And while the differencesbetween a fee-based accountand a per-trade commission accountmay appear small, the fee system's benefitsto the investor can be substantial.
ACTUAL INVESTOR BENEFITS
Under the commission system, a brokeris compensated on the basis of thenumber and size of transactions executed.However, with a fee-based account, abroker's compensation is based on thevalue of the account. Because fee-basedaccounts are size-driven, not commission-driven, the fee-based broker hasgreater personal stake in the success ofeach investor's account.
When a fee-based account is establishedat most brokerage firms, the broker firstdevelops a comprehensive investment profile forthe investor. The profile usually defines theinvestor's risk tolerance, income needs, and overallinvestment objectives. This profile is usually completedbefore any investments are made. It servesas the blueprint for building a portfolio of stocksand bonds based on the investor's specific needs.
Then, at the end of each quarter, the investorreceives a performance review. The fee-basedinvestor always knows what the account's returnshave been, both on an absolute basis andcompared to various indexes. This newtype of brokerage account is designed foraccounts of $100,000 or more, and areavailable at many brokerage firms.Three types of fee-based accountsare generally available at most brokeragefirms. The only difference is who isresponsible for managing the portfolio.The most widely used fee-based accountis one where an outside moneymanager is employed to make all investmentdecisions. With this type of account,the brokerage firm and themoney manager may share the fee. Thisfee is often called a wrap fee because allexpenses are wrapped into 1 fee.
Another type of fee-based accountis one that allows the investor to makethe decisions. This type of arrangementprovides the investor with flexibility.For example, if the stock marketbecomes too volatile, the investor maywant to shift from stocks to bonds.Later, the investor can move back intostocks—all without incurring commissions.
Finally, many firms offer a broker-managedaccount for those investors who want to be somewhatinvolved in managing their account, yet wantto turn the day-to-day responsibility over to thebroker. Most broker-managed accounts are closelymonitored by the sponsoring firm, and at somefirms only experienced brokers trained in managingportfolios are eligible to participate. With bothbroker-managed accounts and accounts managedoutside the firm, the investor gives the manager discretionto make all investment decisions on thebasis of the investor's stated investment objectives.
A FEE-BASED FUTURE
One of the keys to successful investing is theability to evaluate each investment opportunity.When a commission is charged on a trade, someinvestors find it difficult to objectively evaluate theinvestment opportunity. This concern is eliminatedwith fee-based accounts because no commissionsare charged on individual transactions.
The cost of a fee-based account will varydepending on the size and investment objectives ofthe account. For example, the fee for managing a$100,000 equity account might run from 2.5% to3%, whereas the same size fixed-income accountmight be managed for as little as 1% to 1.5%.Thefee percentage may be reduced when the size of theaccount reaches various breakpoint levels.
Fee-based brokerage accounts are here to stay.In fact, many brokers believe that fee-basedaccounts may eventually overtake commissionaccounts as the most popular type of business. Fee-basedaccounts represent a more objective way fora investor to have their assets managed. The brokerand the investor can both concentrate on what isbest for the portfolio—and not be worried aboutcommissions. So the next time your broker callswith a stock or bond recommendation, ask themabout the firm's fee-based accounts.
David C. Rankin is a partner with the Marlton, NJ-based Mangan,
Ernst & Rankin Wealth Management Group of
Wachovia Securities. He hosts the daily morning
drive show, which airs weekday mornings from
7:30AM to 9:00AM on Philadelphia's Money-Talk Radio WWDB
860 AM The show covers topics ranging from
the basics of investing to more complex
retirement and estate planning issues for
individuals and businesses. He welcomes
questions or comments at 877-808-2034.