This post focuses on the “traditional model” relationship for compensating financial advisors and represents the third installment of our Fee Series.
The Traditional Model
The Traditional compensation structure is probably how the movies would envision the traditional “stock broker”. The stock broker gives you a call, has an idea, you either like the idea and buy a stock or you don’t like the idea and you don’t purchase anything.
In this model, you pay your broker/advisor when you buy or sell a security (Bond, Stock, Electronically Traded Fund (ETF), Guaranteed Investment Certificate (GIC), etc.). The costs of this transaction can vary quite a bit, depending on the type of security and the agreed upon compensation with your advisor.
From our experience, this usually ranges between 1-2% of the value of the purchase. To put that in dollar terms; if you were to purchase $10,000 of a stock you would pay your advisor $100-$200. To sell that same stock, you would pay another $100-$200. This means that to Buy and Sell the same stock in a year, you would pay between $200 and $400 (2%-4%) to trade this stock. Assuming of course that the stock didn’t change in value (which wouldn’t be a very good investment).
Advisors can charge the "minimum" for smaller stock purchases, which ranges typically from $100-$150 dollars per trade. This minimum is charged to help compensate for the “ticket charge” advisors will pay with each stock transaction. The people who are executing this trade for you get paid as well, so they typically charge $25-$50 to advisors to make that trade happen. Again, clients don’t typically pay extra for the ticket charge, advisors pay out of their pocket for this “ticket charge”.
Over the years, investors have brought up their concerns with the traditional model. These concerns mainly surround their feelings of not being on the “same side of the table” with their broker when recommendations are made.
While we do not believe that this is an endemic problem with this model, we understand the concerns that some investors express. It is understandable that if an advisor employs and active trading (holding stocks less than a couple of months to try to take advantages of various opportunities) that you would see many transactions in your account in any given year. While you may pay more in transaction fees, you would expect that their performance would be better than mutual funds or indexes.
Like all previous methods of compensation, you cannot “write-off” traditional model compensation you pay your advisor for tax purposes. To summarize, you cannot use Mutual Fund Load Charges, Trailer Fees, or Traditional Model Compensation that you pay your advisor to reduce the taxes you pay. However, there is one final model to compensate your advisor which you may be able to use to reduce the taxes you pay… The Fee-Based Model which will be covered in our next post.