25.1 Introduction

Introduction

Participants in the securities industry have witnessed an ongoing shift away from the traditional advisor/client relationship model toward a fee-based account model. With the traditional model, the advisor is compensated with commissions. The fee-based model bundles various services and charges a fee based on the client’s assets under management. Typically, these accounts are owned by high-net-worth clients (also called affluent clients).

This chapter focuses on the various types of fee-based accounts available in the marketplace, both managed and unmanaged. The products discussed in this chapter clearly show how the compensation model continues to evolve, and how the advisor’s traditional role continues to change dramatically.

Key Definitions

Fee-Based Account: An investment account where the advisor charges a percentage fee based on the assets managed rather than per transaction.

Traditional Commissions: Fees paid to advisors based on individual transactions, such as buying or selling securities.

High-Net-Worth Clients (Affluent Clients): Individuals or entities possessing a significant amount of investable assets, usually defined as those having $1 million or more in liquid financial assets.

Managed Accounts: Types of fee-based accounts where an investment manager makes decisions on behalf of the client, aiming to meet the client’s objectives and requirements.

Unmanaged Accounts: Accounts where clients receive advice from an advisor but make their own investment decisions and transactions.

The Shift: Commission-Based to Fee-Based Accounts

The traditional advisor/client relationship relied heavily on commission-based compensation, where every transaction generated a fee for the advisor. This model often aligned the advisor’s incentives with the sale of assets, potentially encouraging frequent trading to generate more commissions.

Conversely, fee-based accounts offer an integrated cost structure that bases the compensation on the percentages of assets under management (AUM). This method aligns the advisor’s interests more directly with the client’s financial growth, as their compensation grows with the client’s portfolio.

Fee-Based Account Types

Managed Accounts

Managed accounts are full-service investment accounts. Here, advisors take on an active role in managing and adjusting the client’s investment portfolio to meet specific goals. This can involve:

• Portfolio Management: Continuous oversight and adjustment of the allocation of assets.
• Financial Planning: The comprehensive creation and ongoing integration of investment strategies into a wider financial plan.
• Personalized Reporting: Regular performance updates and personal consultations.

Unmanaged Accounts

Unmanaged accounts tend to offer a lower level of direct intervention from an advisor. In these setups:

• Advice: Advisors provide consultation services but do not make decisions.
• Execution: Clients are responsible for executing investment decisions based on the advisor’s input.

Advantages of Fee-Based Models

1. Transparency: With a clear fee structure, clients understand exactly what they are paying for.
2. Alignment of Interests: Advisors benefit when clients’ portfolios grow, aligning their financial interests more closely with those of their clients.
3. Holistic Services: Advisors often provide more comprehensive financial planning, investment strategy, tax planning, and estate planning services.

Disadvantages of Fee-Based Models

1. Cost: Initial costs may seem higher since clients pay a continuous fee rather than transaction-based fees.
2. Performance Pressure: Advisors are directly responsible for portfolio ups and downs, which can create extra pressure to perform.

Frequently Asked Questions (FAQs)

What is the primary difference between managed and unmanaged accounts?

• Managed accounts involve active asset management by the adivisor or investment manager. Unmanaged accounts rely on the client to make investment decisions with advisory input.

How is the fee calculated in fee-based accounts?

• The fee in fee-based accounts is typically calculated as a percentage of the assets under management (AUM). Common rates range from 1-2%, but it varies based on account size and services offered.

Are there potential conflicts of interest in fee-based models?

• Fee-based models reduce certain conflicts of interest inherent in commission-based models but can introduce new ones, such as prioritizing gather assets or annual fees over performance. Transparency is critical.

Key Takeaways

• The fee-based model represents a significant shift in how advisors and clients interact in the securities industry.
• Fee-based models can offer greater alignment of interests, transparency, and a broad array of bundled services compared to traditional commission-based models.
• High-net-worth clients often benefit most due to their greater asset bases which justify the cost of enhanced services and personalized management.

Understanding the growing prominence of fee-based accounts is essential for anyone navigating the evolving landscape of the securities industry, aiding in making informed investment selections to meet individual financial objectives.