The Secret Incentives That Lead "No Commission" Brokers to Push Higher-Fee Products
Motley Fool Staff, The Motley Fool
Updated
If you go to a discount broker who isn't getting paid on commission, you might think the broker is putting your interests first. Turns out the brokerages may not have those brokers on "commission," but they do pay them "incentives," including a higher percentage for the more profitable, heavier fee options.
In this segment from the Motley Fool Answers podcast, Alison Southwick and Robert Brokamp chat about these hidden compensation structures, why they ensure some customers will be subtly steered toward financial products that aren't the best choice for them, and how you can pick a financial advisor who is more likely to have your back.
Alison Southwick: Well, Bro, I have been reading what I've read many times in the past, and that is the writings of Jason Zweig over at The Wall Street Journal. He and reporter Anne Tergesen went and interviewed dozens of former employers from the three largest discount brokers by assets, So, Fidelity, Schwab, TD [Ameritrade]. And they asked them not necessarily how they are incentivized through commissions, but other ways that they are perhaps incentivized to put financial products in front of their clients that maybe are not the best for them. That maybe charge higher fees.
And so for example, Fidelity representatives are paid 0.04% of the assets clients invest in most types of mutual funds or exchange-traded funds, but they earn twice as much, more than twice as much -- 0.10% -- on choices that generate higher annual fees for Fidelity.
Robert Brokamp: Oh, really!
Southwick: So, managed accounts, annuities, and referrals to independent financial advisors. A quote in here is from a guy who used to work at Fidelity. He said, "Clients hear the representatives don't work on commissions, and they think that means a rep doesn't work on incentives."
Brokamp: That is fascinating. I think by far the average person who calls up Fidelity or any of these other discount brokers are thinking they're getting pretty objective advice.
Southwick: Yes. So, The Wall Street Journal looked at, again, Fidelity's achiever bonus -- I just pulled this example out of the article -- and it could add up to more than $92,000 a year, the bonuses that they can get. And so it's a pretty long article, and I like to, of course, scroll down to the comment section.
And once you get past the comments that blame Trump or Obama, the comments kind of fell into two different camps. One camp was the, "Well, duh!" Kind of like, "This is how they make money. This is Wall Street. Wall Street's evil." Or it was like, "Well, duh! What do you expect? Fidelity is not a charity. They have to make money somehow and incentivize people." But there were quite a few people who were like, "This was not my experience." And my biggest question, I guess, coming away from it is how would you know?
Brokamp: Right.
Southwick: Because if something can be gamed, it will be gamed, and incentives are there for a reason, to get people to do a specific action. I'm asking you now. How are you able to even know?
Brokamp: That's a really good question. Of course, you can ask, but you don't know if you're getting the right answer. You would think that some of this is disclosed in something that you signed when you became a customer, but whether there are specifics there, I doubt it. The bottom line, what this demonstrates, too, is these are all ex-employees.
Southwick: Yes.
Brokamp: So, whether it's there, or sites like Glassdoor, or other places, people talk, and if you do enough digging, you'll find out somewhere the incentives behind the stuff. But it's not going to be right there, up front. You're going to have to do the research.
Southwick: Yeah, well, that's just it. We've talked about in the past, a fair amount, on how to find a financial advisor, but for those who are maybe new to the show, what is your best takeaway for people hiring a financial advisor to make sure they're getting one that is putting their interests first?
Brokamp: Well, so, we've talked about, frequently, someone who is truly fee only, which means you are just paying for the advice. You might be paying for assets under management, but it's very clear and up front, and someone who is a fiduciary. So they are legally obligated to put your interests first. That, to me, is the No. 1 advice. I think you can still get good advice from a company like Fidelity, but you just might have to do a little digging to find out exactly where the incentives are.
Southwick: Anyway, a fascinating article from The Wall Street Journal. Again, it's Jason Zweig and the reporter is Anne Tergesen if you would like to read it and enjoy the comments, because people get snarky. Pop some popcorn.
Alison Southwick has no position in any of the stocks mentioned. Robert Brokamp, CFP has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
