The Shell Game

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A very busy emergency physician, Dr. Smith turned to a financial advisor – Frank – to handle his investments. Initially Dr. Smith was happy, but eventually realized he didn’t understand the investment strategy.

Is your financial advisor hiding fees? The only way to know is to take a close look at how they are getting paid.


A very busy emergency physician, Dr. Smith turned to a financial advisor – Frank – to handle his investments. Initially Dr. Smith was happy, but eventually realized he didn’t understand the investment strategy.

So Dr. Smith reviews his investment statements for the past few years. He notices that the names of the mutual funds don’t make sense to him, but that most of the funds have the letters “A” or “C” at the end. A quick Google search reveals that these funds pay kickbacks to advisors who sell them. Going back to his investment statements, he can’t figure out what fees he’s paid to Frank. In fact, he can’t recall that he’s ever had a discussion of fees with Frank. He’s never written any checks to him directly and doesn’t see a fee payment in his account statements.

Why Advisors Hide Fees
Most physicians have no clue what fees they’re paying to their advisors and yet we willingly buy these services. You want to know what these fees are but you’re afraid of confrontation.  Fellow EPs, this isn’t the prom. You’re not going on a date.


Most advisors either don’t tell you their fee, or if they do, it’s a secondary issue that’s brushed off like a fly on the back of your neck.

I’ve got a theory about why they do this: because the fees most advisors charge are too high and they know it! Let’s take a look at the pros and cons of how advisors are paid:

These advisors sell you a mutual fund or insurance product and get a kickback for doing so. The fee is embedded within the product itself. For example, let’s say the advisor sells you a variable annuity. The payments in the annuity don’t all go to the investments within the annuity. Part of the payment goes to the advisor. In effect the advisor is now tied to the product and not to you. It’s no different that if you show up at the Ford dealer. What are the chances they’ll sing the praises of Honda?

For example take the Rydex S&P 500 Class C fund, a commission-based fund that invests in US large company stocks. This fund has sky high expenses of 2.28% annually, but the equivalent Vanguard 500 Index Fund, which has no commissions, has expenses of just 0.18%. A commission-based advisor won’t tell you about the Vanguard fund because he doesn’t get anything out of it.


Most commission-based advisors are affiliated with large firms–banks, brokerage firms–so one advantage of a commission-based advisor is the psychological comfort you feel in being associated with a large institution. I suppose the second benefit is that some people would rather not see the fee they’re paying to their advisor. They simply don’t care what it is. After all if it’s out of sight, it’s out of mind right? If you don’t see it, you feel like you’re paying nothing. You might be OK with that.

This is where advisors twists words out of context and make themselves look more ethical than they really are.  On the surface, fee-based advisors appear to avoid the conflicts of interest of pure commission-based advisors. The problem is that fee-based means that the advisor can charge you a fee directly and can sell you products for a commission.
There’s two ways this usually works. First, a fee-based advisor might provide financial planning services and do a written financial plan. But guess what recommendations he’ll make in that written plan? Mutual funds which pay him a commission. So he writes the plan, recommends commission-based mutual funds in that plan, and then sells you investments for a commission.

The second way is that the advisor charges you a fee directly for managing your investments without accepting commissions and at the same time sells you insurance.

Unfortunately, fee-based advisors mask their fees under the name of “independence” to make it look like they are objective in their advice. While they might not necessarily be paid by a specific brokerage firm, if any part of their compensation comes from commission-based products, there is still a conflict of interest. That’s not true independence.

Fee Only
The most ethical compensation is fee-only compensation. A strictly fee-only advisor is paid only by the client, does not sell products, receives no commissions, does not accept referral fees, is truly independent, and acts as a fiduciary.  A fee-only advisor is like a CPA except on the investment and financial planning side. You pay a fee directly to the advisor, and the advisor provides you with financial planning advice, investment management, or both. It’s pretty clear cut because nobody else is involved in the transaction. Notice this is different than fee-based because fee-based advisors can still accept kickbacks from product selling.

Most commonly fee-only advisors charge a percentage of the assets they manage (assets under management or AUM model). This might involve managing investments, or managing investments and providing financial planning advice. Typically the AUM compensation method involves ongoing long term investment management. Other fee-only advisors charge hourly fees.  They will provide a written financial plan but then you implement this yourself.
While fee-only compensation is clearly the most transparent and overall ethical way to do business, be careful. Suppose you are deciding between paying off your mortgage versus investing. A fee-only advisor charging an AUM fee would get paid more if he advised you to invest more, but what if paying down your mortgage is better? What if you’re saving enough to meet your goals and don’t really need to invest more? On the other hand, hourly financial advisors may be tempted to bill you more.

Many fee-only advisors will charge you an AUM fee for managing your investment portfolio and providing financial planning advice. Most people don’t need “continuous” financial planning. How often do you need to change your disability or life insurance, or change your will? Yet a lot of fee-only advisors charge you for this advice annually and lump it all together into one big fee when they’re really just managing your investments. Why should the fee you pay for insurance advice be tied to the size of your investment portfolio anyway? And finally, many fee-only advisors give you the illusion that it takes many times more effort to manage a $1 million portfolio versus a $100,000 portfolio. That’s simply not true. It takes some more effort but not a whole lot more. So why should the physician with a $1 million portfolio pay 10 times more fees than the physician with a $100,000 portfolio? Most fee-only advisors won’t tell you this.
The bottom line is to make sure that no matter how you pay an advisor, make sure he discloses all of this upfront.

Setu Mazumdar, MD practices EM and he is the president of Lotus Wealth Solutions in Atlanta, GA

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