The Right Way to Pay for Financial Advice May Not Be the Obvious One

The dirtiest word in the financial business is still “load”--as in sales load, or upfront commission on a mutual fund or other packaged investment product.

At least that’s what a 1996 consumer survey by financial consulting and research firm Dalbar Inc. of Boston indicated.

“Americans vote against paying loads for advice,” Dalbar trumpeted in its survey. It found that fewer than one in 10 people want to pay a load for personal financial help.

Instead, most people declared that if they had to pay an advisor (broker, financial planner, insurance agent, etc.), they wanted to pay a flat fee for a product, or a percentage of their assets each year for ongoing help in managing their money.

What people supposedly want, however, differs markedly from what many get. Load mutual funds accounted for 43% of industry sales year-to-date, through July, according to the Investment Company Institute, the funds’ main trade group. No-load funds accounted for 47% of sales, while the rest were sold via

annuity products.

On the surface, those numbers suggest a few things. First, when set next to the Dalbar study, it would seem that the vast majority of people who are buying load funds, and paying the typical 5% (or thereabouts) commission on the money invested, must be terribly unhappy doing so. (More on that later.)

Second, the 47% market share figure for no-loads seems to indicate that do-it-yourself investors are becoming the rule rather than the exception. All you need to buy a no-load fund, after all, is some money and the ability to dial an 800 phone number.

*

But those market share numbers aren’t quite what they seem. As many investors already know, hundreds or thousands of mutual funds today can be purchased load or no-load, depending on the channel used (i.e., direct from a broker, via a 401(k) retirement plan, through the growing number of fund “supermarkets,” etc.).

The ICI, however, counts a fund as load or no-load each month based simply on where the majority of its sales occurred. So if 51% of a fund’s sales occurred without a load, it would count toward no-load market share--ignoring the 49% of sales via the load channel.

What about the apparent triumph of do-it-yourself investing? Not true at all, according to most industry data. In fact, the ICI, in a 1995 study, found that 70% of investors buying mutual funds did so using the help of a financial advisor of some kind--even if the advice was to buy no-load funds, with the advisor’s compensation coming in some form other than a traditional load or commission.

A newer study by Cerulli Associates of Boston confirms that many no-load fund purchases are actually facilitated by advisors on behalf of the investor.

One can make a case that there’s a lot of good news in these numbers. If more people are seeking professional help with their investments, it probably means they’ve reached a point where they sense that it’s too dangerous to their long-term financial well-being to be totally on their own. (Undoubtedly, some advisors will do more damage than good--but then, so do some doctors and lawyers.)

What’s more, the proliferation of advice givers, and the variety of ways in which those advisors are willing to be paid, show that the free market is working quite well: Because more Americans say they want to pay for advice with flat fees or with a set annual fee that is a percentage of the assets their advisor is overseeing, the market has moved in that direction. Plenty of financial planners and brokerage reps today will work under either a commission setup or a fee-based setup.

“In terms of pricing structures, they’re all out there now,” says Stephen Allen, national sales manager for mutual fund firm Lord, Abbett & Co. in New York and a member of the executive committee of the Forum for Investor Advice, a 73-firm organization of brokerages, fund companies and other financial concerns.

“Clients, based on what they want to pay, can get anything they want,” Allen notes.

Then why do so many investors still pay commissions, or loads, if the Dalbar survey showed that those charges are so hated?

Maybe, on closer inspection, investors don’t find loads so abhorrent after all.

The Forum for Investor Advice, interestingly enough, was formed three years ago when many load mutual fund companies and brokerages worried that no-load sales were going to so dominate the industry that load funds would wither. That obviously hasn’t happened.

*

Today, the forum sees its mission as far broader than preserving the load mutual fund structure. Wisely, the group’s members, including Merrill Lynch & Co., the Franklin/Templeton funds and the Los Angeles-based American Funds, now are stressing that the true value added to their products is that they come with the advice of a financial professional. (Hence, the forum’s current name, changed from the bland Mutual Fund Forum.)

“The real issue is [professional] help versus self-help,” Allen says.

John Lotka, a vice president at John Nuveen & Co. in Chicago and another forum executive committee member, says the group understands many investors’ desire to choose financial services a la carte, and as needed, as they go through life.

“People go through varying degrees of needing help, not needing help, being interested, not being interested” in investing, he says. “But there are times in your life when you’re so busy and so successful that you’ve got to have somebody there to help you. Or you could be completely missing huge opportunities.”

The forum’s message is that traditional load funds are available with that help, and with the added dimension of many different ways to pay for that help. But the message also is: Pay you must. You shouldn’t expect to get decent help for free.

Fee-based compensation plans have appeal for obvious reasons. If your advisor is taking 1% of assets each year, rather than a commission on each purchase, he arguably has less incentive to sell you investments for the sake of making a sale, and more incentive to make sure your assets grow.

But some forum members insist that traditional, upfront loads are exactly the right payment choice for many investors. How so?

If all you really need is help picking a few good mutual funds, and the willingness to hold them long-term, making regular purchases with upfront loads may cost you less, over time, than paying an advisor 1% to 2% of the portfolio each year for 20 years to constantly fine-tune it.

“Over time, action isn’t necessarily success,” notes Tom Miltenberger, partner at brokerage Edward Jones in St. Louis and a forum member.