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By al hewitt, cFp B

y taking the time to read this report you will learn how the financial services industry does business ninety-nine per-

cent of the time. You will find that it is in your best interest to become part of the other one percent.

The financial services industry is

famous for complicating the way you choose a financial advisor, and how they are compen- sated. With over fifty types of financial certi- fications, varying compensation models, and multiple regulatory agencies, the industry has created a mass confusion. Here are the two most common business models used by advi- sors in providing investment advisory and fi- nancial planning services:

commissions on Financial proDucts: how they work The advisor is paid by, and works

for, someone other than you such as: a credit union, broker dealer, brokerage firm, bank, or an insurance company. Many financial advisors will give away free financial advice and even a “boiler plate” (computerized financial plan); in turn, you may purchase recommended financial or insurance products from the advisor (mutual funds, annuities, insurance, etc). The advisor will receive a commission from the product company. Commission payouts range from 1% to over 10% depending on the type of products purchased. The goal of commission based advi- sors is to get hundreds if not thousands of cus- tomers to buy the product they are selling. The advisor must constantly solicit for new busi- ness to earn commissions limiting the advisor’s time to manage your financial plan.

commissions For proDucts: the intent The intent of commissions for invest-

ment products is you only pay once or not at all if you keep your assets with the same company for a specified period of time. Some products have up-front sales charges as high as 8.5% while others have no up-front sales charges.

Reality – Financial service providers may have agreements with certain mutual fund and insur- ance companies that pay more commissions and give the firm various incentives that you may never know about. These programs have various names that may include: premier spon- sor, strategic partners, revenue sharing, market-

ing support programs, and preferred provider arrangements. Most com- mission based advisors will use only one fund family, limiting the selection of money managers, making diversifica- tion difficult to achieve. Competing product companies also pay the advisor a differing amount, especially for selling annuities and life insurance. If one product pays a commission of 10%, the advisor has no incentive to offer you a product with lower annual fees that only has a commission of 1%.

Reality –The products you will be sold have higher annual fees than many other types of products currently available in the market- place. These fees and charges could range from 2% to 5% every year and will erode your portfolio. These include: 12b-1 fees, account fees, management fees, tax charges, turnover costs, mortality and expense charges, living benefit expenses, enhanced death benefits, sub- manager fees, and SAI charges (Statement of Additional Information). These fees are for trading expenses, custodial expenses, legal and accounting expenses, transfer agent, and other administrative expenses. These fees and ex- penses will have a significant impact on your long-term wealth. For example, if you have a $250,000 investment and receive an average annual rate of return (after expenses) of 8% for 20 years, an additional 2% of annual expense charges will cost you $319,406 over that time. Other fees and charges you could incur may be sales loads, contingent deferred sales charges, surrender charges, exchange fees, redemption fees, dealer spreads, and purchase fees.

Conflict – Many advisors and their employers receive multiple incentives which can be mon- etary or non-monetary for using certain invest- ment and insurance companies. Some of the incentives are: payments for advertising, gifts, bonuses, soft money incentives, paid trips, va- cations, seminars, food, etc. Commission based advisors are not required to disclose all con- flicts of interest, and they do not want you to know they exist. These multiple conflicts make it difficult to determine if you are choosing an advisor that will be working for you or one that will be working for the interests of their em- ployer and the various product companies that pay the advisor’s commissions.

Conflict – Brokerage firms and broker dealers have many business practices that have built in conflicts of interest which may include: pay- to-play, directed trades, revenue sharing, in- house products, make-a-market in securities, and underwriting new securities. These built in conflicts may limit the selection of investments available and your advisor’s ability to provide the most cost effective solution for you and your family.

Conflict – Commission and fee-based advisors are not held to a fiduciary standard. Fiduciary standards are only required for Registered In- vestment Advisors (RIA’s) and Investment Advisor Representatives (IAR’s). Commission and fee-based advisors are held only to a suit- ability standard. Advisors that are held to the fiduciary standard must comply with the fol- lowing: sign a Fiduciary Oath, display loyalty to you, not be compensated by anyone other than you, not be affiliated with any competing interests, fully disclose all conflicts of interest, do not receive referral fees from other service providers, and do not receive financial incen- tives for recommending specific financial or insurance products. It is estimated that over ninety-five percent of financial advisors are not held to the fiduciary standard.

Conflict – By using commission and fee-based advisors, you may be supporting other organi- zations and companies you do not even know about, such as: credit union organizations, banks, brokerage firms, insurance companies, and various multi-level sales groups. Ask ques- tions and perform proper due diligence on oth- ers who benefit by you doing business with the advisor and their employer. You may find that you will be supporting organizations and com- panies that are not part of your core values.

Alan E. Hewitt, CFP®, AAMS, AWMA, EA, ATA, ATP can be reached at (800) 573- 4829 or visit his website at

May 2012 • 43

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