Fee Vs Commission: Which Advisor Is Best?

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Physician's Money Digest, November 2005, Volume 12, Issue 15

Recently an old friend came upto me and asked, "How canyou write that no-load fundsare better than load funds when youcharge your clients a 1% fee eachyear?" Hmmm, I suppose it is true thatI have a strong bias toward no-loadmutual funds over their loaded counterparts.This particular friend worksin the investment department of one ofthe local banks where he sells loadmutual funds. Clearly, this was not theplace to debate this subject. For financialadvisors, the subject of "load vsno-load" is the equivalent of debatingreligion or politics. But this topic deservessome discussion.

First, let's look at why I have a biasagainst load mutual funds. My negativebias has evolved from my experiencesover the past 30 years in thebusiness. Load mutual funds have severaldrawbacks.

Limited Fund Choices

Once you decide which fund to buy,you lock yourself into that particularmutual fund company. The reason isthat you just paid a load (typically5.75%), and if you decide to moveyour money to another mutual fundcompany you would face a brand newcommission charge. It is true that youcan move your money around withinthe fund company you have chosenwithout charges, but this will reduceyour choices to several dozen fundmanagers compared to nearly 5000 inthe no-load fund universe. I remembera case where we reviewed a newclient's portfolio and he had recentlypurchased a load fund with a veryimpressive manager. Within a month,the manager left the company andstarted his own fund. In order to followthat manager, should the clientpay another 5.75% load?

Brokers also often sell back-loadedfunds where you don't pay a front-endload, but you are charged a surrenderfee if you move your money from thatparticular fund family during the first 5to 7 years. Again, this tends to handcuffyou to that particular fund company.Many of the fund companies havesome excellent fund managers, but Ihave never found one that has the topmanagers across all the different investmentcategories you will need for properasset allocation. For example, maybethey have an excellent domestic largecap manager but a mediocre internationalstock manager. Of course, ideallyyou want to have a top manager foreach category of investment.

Compensation Conflicts

With load mutual funds, the brokerreceives a large commission forsigning you up. For example, on a$100,000 investment, a commissionof $4500 is typically paid. Beyondthe initial commission, trailing commissionsof 0.25% or more are alsopaid annually. As the client, youexpect that the advisor will continuouslymonitor your investments andmake recommendations for changeswhen appropriate. My actual experience,however, is that beyond the initialinvestment of the funds, there arevirtually no changes in the portfolioeven years later. Logic would suggestthat your portfolio is, in fact, notbeing managed at all. Once the brokersold you a basket of mutualfunds, they moved on to the nextsale, all along collecting their trailcommissions with very little service.

Compare this to the typical fee-onlyadvisor who is using no-load mutualfunds. The typical fee is 0.25% to0.30% billed quarterly based on theamount of assets under management.This method of compensation placesthe advisor on the same side of thetable as the investor, where the advisoris rewarded as the account grows invalue or penalized if it goes down invalue. It also encourages active monitoringof the investments and communicationwith the investor, since ineffect, the advisor is being paid by theday instead of a large lump sum.

Upon reflection of the brief conversationwith my friend, I realized thatnot all advisors selling load funds doa poor job as I have described. I suspectmy friend and many like him aredoing excellent work for their clientsand are deserving of the commissionsthey are receiving. Therefore, the litmustest goes to the investor. If youown load funds, is your experiencesimilar to what I have describedabove? If so, you should consideryour options. If not, then you havetruly found an advisor who is puttingyour interests ahead of their own.These advisors are worth their weightin gold and deserve your loyalty.

, is the founder

of the Welch Group, LLC, which specializes in

providing fee-only wealth management

services to affluent retirees and health care

professionals throughout the United States.

He is the coauthor of J.K. Lasser's New Rules for Estate and

Tax Planning (John Wiley & Sons, Inc; 2001). He welcomes

questions or comments at 800-709-7100 or visit www.

welchgroup.com. This article was reprinted with permission

from the Birmingham Post Herald. My thanks to my partner

Scott Lee for his assistance with this article.

Stewart H.Welch III, CFP®, AEP