OTTAWA – There’s a scene in “The Wolf of Wall Street” where the cocaine-fuelled character of Mark Hanna, played by Matthew McConaughey, lays out the No. 1 rule about the stock markets.
Nobody knows where they’ll go.
“But you and me, the brokers? We’re taking cold hard cash via commission,” he tells Leonardo DiCaprio, who stars as stockbroker Jordan Belfort.
The over-the-top exchange illustrates why commission-based financial advisers may not serve one’s interests.
The choice between a fee-based adviser or one who gets paid through a commission is an important decision for investors.
Andrey Pavlov, a finance professor at the Beedie School of Business at Simon Fraser University, says he prefers the fee-based system.
“I think it is the right model because then the adviser is clearly working for you and they have your best interests in mind,” he said.
“When someone is working based on commission, they can be honest and they can very much care about you, but still they’re getting paid based on the mutual funds they sell you and I don’t like those incentives.”
Fee-based advisers may charge an hourly rate, a flat fee or a percentage of the assets under management, while commissioned-based advisers earn a commission when you buy or sell an investment.
Pavlov says while “99.9 per cent” of advisers will act in your best interest, commissions create a potential conflict of interest.
“With fee-based it is very clear what you’re paying and the incentives are aligned,” he says.
Pavlov says the fee-based model is going to be more efficient for larger accounts, but he likes it for smaller investments too because he says it aligns the incentives.
“I want to pay for the time and effort that the adviser (puts in) rather than some sort of sales job that I’m not even aware of,” he said.
A fee-based adviser, however, isn’t for everyone.
Sybil Verch, national director of wealth management at Raymond James, says the vast majority of her clients are fee-based.
But Verch said a commission-based account may be cheaper for clients who don’t trade much and don’t need the financial planning services an adviser may offer.
One example, Verch says is a client with just a laddered GIC portfolio that doesn’t do any trading.
“They’re retired, they don’t need any more planning, they’ve got adequate pension income. They don’t need any of the other added services,” she said. “They just renew their GICs every time it comes due.”
Fee-based financial advisers also aren’t without their potential conflicts. For instance, if you receive a windfall inheritance, fee-based advisers who earn a percentage of the assets under management would be paid more if you invested the money with them than if you used it to pay off a mortgage or other debt.
In addition, there are limitations to fee-based accounts. Most firms limit the number of trades one can make in a year and charge more if clients go over that number.
Investment fees, which cut into returns, have been a key issue for investors in recent years and a driver of a move by some toward exchange-traded funds, which typically have low fees.
Under changes this month, investment brokers and dealers now need to start reporting annually on what they were paid for the products and services they provide.
The Canadian Securities Administrators has also announced that it’s looking at the possibility of banning embedded commissions or trailer fees, a move that Britain and Australia have already taken.
A report done for the organization found that funds that performed better attracted more money, but that funds with trailing fees attracted more money regardless of past performance.