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Investors don't understand commissions


Investors are willing to pay for financial advice but hate to pay mutual funds' loads. And they dislike, and misunderstand, commissions. They claim to prefer a flat dollar fee for services, but a quick reality check finds that usually isn't the case.

Dalbar Inc., a Boston financial services industry research and publishing company, has been conducting a nine-part survey of investors and how they seek financial services. The latest part of the survey, on how customers prefer to pay, is interesting but curious, since the most popular choice -- dollar-based flat fees -- is rarely offered in the form most investors would like to see it. And, experts say, they would probably reject it after they saw it.

As defined by the 4,103 consumers questioned, flat fees were dollar amounts charged for the services offered, but independent of the amount of money invested or the transaction executed.

The most common dollar-based fees are for strategies drawn by financial planners. The actual investing, and the management of the investment, when done by planners or stockbrokers or some people who are both, is now commonly paid by commission, sales loads on mutual funds or, increasingly, a percentage based on the value of the assets under management.

Why that method instead of a flat fee? "People just don't like to write checks," said financial planner Ron Roge of Centereach, N.Y., who charges a flat fee for a complete financial plan but

asset-based fees for investments.

Jay Mandelbaum, executive vice president of marketing and client services at Smith Barney, said, "If clients had to pay a flat fee for the planning, then pay an implementation fee at another level, that could cause sticker shock."

Dalbar President Louis Harvey said that while most investors said they would like the flat fee, "financial advisers fear it will hurt their incomes" because investors will be turned off by the high real cost of the services.

But there is another problem with upfront flat fees, as well as with sales loads and commissions. The fees paid upfront mean the investor is betting on the come, as they say at the craps table. You have paid all your money and if the investment doesn't work out, you can change your adviser, but you have already paid to play.

But with asset-based fees, which aren't cheap (often 1 percent to 1.5 percent of the amount invested), the fee is generally deducted quarterly or monthly and is in addition to the management fees of any mutual funds. Investors can pull out when an investment goes south without losing a big fee.

The disadvantage to the investor -- and the advantage to the financial adviser -- is that if the investment grows, the fee grows, which doesn't happen with a one-time fee.

Some advisers will charge flat fees for certain kinds of investments. Walter Wisniewski, president of Paragon Capital Management in Syosset, N.Y., said he doesn't charge his 1 percent asset fee to investors who have portfolios solely of U.S. Treasury or municipal bonds because it would erode the yield on the bonds.

"The percentage wipes out some income," he said. "We charge some of our elderly clients who have only those bonds a flat fee and review their portfolios quarterly." Other planners say they make the same exception.

Not all financial planners charge asset-based fees. Some, like Joseph Clinard, a planner and partner in North Shore Capital Management in Melville, N.Y., collect commissions on investment products sold.

Clinard prefers rear-load funds in which the commission disappears if the investments are held over time. But other, sometimes less perceptible charges, such as 12b-1 distribution fees, make up for obvious commissions.

He doesn't like front-load funds, which reduce the amount of investment because the commission comes off the top. "Nobody likes to take a haircut," he said.

Dalbar's respondents agreed. They considered loads to be fees paid to the mutual-fund company that represent no particular value. They misunderstand that loads are the way commissions are paid to distributors and brokers for selling the mutual fund.

In fact, the driving force behind investors' choice of the flat fee and asset-based fee was their desire to avoid all commissions.

But the consumers in the survey also seemed to misunderstand commissions, mistakenly believing that brokers have to work harder to get a commission or that brokers share in the gains and losses because they received a commission.

"These misconceptions," the report says, "represent more than half of commission supporters, making commissions the least rational choice. As consumers become more knowledgeable, the confusion will be eliminated and commissions will become less acceptable."

Smith Barney and Merrill Lynch seem to see that handwriting on the wall. Both have major fee-based programs for individual investors, as well as the standard commission system because, Mandelbaum said, customers want a choice.

Both firms will even buy and hold no-load funds in customers' accounts if they sign up for the asset-based fee programs.

The reasons: Having assets under management is a more reliable source of income than simple sales, particularly from buy-and-hold mutual fund investors. The more money managed, the greater the fee income.

"The name of the game is 'share of the wallet,' " said Dalbar's Harvey. "The financial advisers realize their customers are using other people, so they want to get their share, and their fees, based on the success of their investments."

How investors prefer to pay

Flat fee (a fixed dollar amount): 46 percent.

Asset-based fee (an annual percentage of the assets): 24 percent.

Commission (a fee added to the transaction): 23 percent.

Load (a fee hidden in the price of the investment that consumers assume goes to the mutual fund company): 4 percent.

Source: Dalbar Inc.

Pub Date: 12/01/96

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