There's a fee war brewing, only it's not the kind you might expect.

It's not about the dollars or the basis points or even the source. No sooner had the White House declared war on conflicts-of-interest (i.e., where advisors get their fee from) than nefarious elements within our brotherhood sought to immediately change the terms of the debate to how advisor fees are calculated. Can't we nip this one in the bud before we convince ourselves our services have no economic value?

Asset-based fees: This represents the traditional RIA compensation metric. It best aligns the interests of the client with the interests of the adviser. If the adviser selects winning investments, client assets rise and so does the adviser's compensation. If the adviser selects losing investments, clients assets fall and so does the adviser's compensation. You can't get any simpler or fairer than that. Long the preferred form of fees basis for the fiduciary, it removes all conflicts of interest when it comes to selecting investments. (Along these lines, asset-based fee structures have recently evoked controversy as some advisers have sought to charge different rates for different asset classes, presenting a classic conflict-of-interest.)

Hourly/project-oriented fees: This model is growing in popularity, but only because of the weakness in applying asset-based fees to services other than investment management. Other financial service providers, who naturally supply other financial services, saw the revenues generated from asset-based fees and, perhaps thinking “Investment management just a component of financial planning,” used this same compensation method for traditional financial planning services. The weakness of this approach became apparent when, unlike the continuous nature of investment management, financial planning activities are generally time-constrained or transaction-based. Competitive advisors discovered they could create a business model based on hourly rates (one-time project fees are a form of this), that allowed them to underprice asset-based fee financial planners. For non-investment management traditional financial planning services (including the annual 401(k) plan participant meeting), this is likely to be the dominant form of fees in the future.

Annual fees: What happens when the assets get so large an asset-based fee leads to ridiculously large sums of money? This is where the annual charge takes over. Mind you, this annual charge is still ridiculously large, but that's why it's only used for those rare mega-sized institutional clients whose assets inhabit the universe of nine-digit numbers. There's still a problem of misaligned incentives with this (see the S&L scandal of the 1990s), but those smart corporate types think they can defend this compensation model.

There you have it. Don't be a fool. Pick the fee model that best aligns with the services rendered.

Instant Insights /

401(k) fee foolishness

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