Sometimes you think you are on the right path and then that path takes a completely left turn. I had a moment like that this week when I started to learn more about the common compensation practices for wealth managers on Wall St. Through my writing and my interests, I had started to realize that personal finance may be something I am passionate about more than just for myself. Rather, it’s a tool that can be used to help people empower themselves and their lives and maybe sharpening that tool for people or even just making them realize they have the tool in the first place, could be a good fit for me.

So I was well on my way towards implementing my long term plan: positioning myself for a career pivot and laying the groundwork for the next stage of my life. I had that path was moving towards becoming a wealth manager. Then I came across the compensation scheme for financial advisors for many large wealth managers and was quite disheartened as to what I saw.

Essentially the model that was explained to me confirmed a poor experience I had with a wealth manager a few years ago which I will explain here because I believe this attitude from many financial advisors is typical.

At that time, I was convinced to move an old 401k and a Roth IRA over to the wealth manager’s bank with the promise that I could choose my investment and that there would be very small or even no fee. I had wanted to do this because my old 401k and Roth IRA were still in funds that charged particularly high fees. I had no choice on the matter when they were started since they were limited to what my employer at the time offered and what had been started for me as a gift from my father (the Roth IRA with a few thousand dollars in it). I repeatedly asked detailed questions about the rollover, my options once the money was there and my financial plan going forward. Once the money arrived though, it was a different story.

When the money hit the bank, the junior wealth manager that I had been dealing with was pushed aside and I dealt with a middle ranking wealth manager who was more my peer in the business in terms of experience. He immediately started pushing funds with high management fees on me that I had explained very clearly from the beginning I didn’t want. I calmly re-explained the terms on which I had moved my money over and what I expected from them. Despite prior assurances from the wealth management office, they seemed hell bent on pushing a particular fund on me which they claimed had great historical returns. I guess they didn’t know who they were dealing with.

I provided them with academic research pointing towards the fact that managed funds will likely not achieve the return they are claiming I would achieve over the long term. I also reiterated the fund I wanted to buy and they looked at me like I was crazy. All I wanted was a target retirement index fund for all my retirement investments and to never touch it. Even if this isn’t the sexiest investment, I pointed to the fact that it was well diversified, didn’t need to be adjusted manually based on my age and that research from Fidelity, one of the largest wealth managers, showed that the accounts where people forgot they had the money, outperformed all other accounts over time.

I also went the extra mile and did the research on the fund they had recommend to me. Being the personal finance nerd that I am, I was aware that fees needed to be disclosed if there are any load fees. I found out that this fund charged an exorbitant up front los fee of 5% in additional to an ongoing fee of over 1% for management. This was definitely not what I had bargained for which I highlighted to the wealth manager. His response was, well we manage over $500 million in this office so I think we know what we are doing. That may work for someone who started a widget factory and sold their great business, that doesn’t work for someone who knows the back end of the business and that the wealth manager splits a fee with the fund provider for distributing their funds.

To make matters worse, they told me I couldn’t even buy the fund I had originally requested because it wasn’t available on their platform. That did it for me. I felt totally bamboozled by them and requested they move my money out of their office. At that point, they involved the senior wealth manager of the office who read the email trail (I made sure this was all in writing) and apologized and offered to waive the fund fees and offer their services for free. The answer without hesitation was “no”. They had violated my trust by lying to me until they had my money and tried to pull the old bait and switch on me. It’s as si woke as that.

I have to admit though, their psychological tactics were strong. A few times I found myself second guessing my own knowledge as and reinforcing it by going back and doing some reading, and I’m an expert. I can’t imagine what it would be like for someone who didn’t have that detailed knowledge and wasn’t already well versed on independent studies which countered what the wealth managers were telling me. I may have easily caved if that were the case.

The Model

In my mind this was just one bad apple, but apparently they were just acting towards what the system was designed to reward them for.

The wealth management compensation system which was explained to me the other day works loosely like this:

• The wealth manager has access to a platform. This platform only has approved funds on it. If the wealth manager is associated with a large bank, then there will be many of the bank’s own funds on the platform, but also likely other funds.
• Each fund has different fees which it offers, which, as I mentioned above, are split between the wealth management bank and the fund provider.
• The actual wealth manager herself gets a percentage of what the bank keeps. They usually don’t know this level of detail, they just are given a commission schedule by their employer.
• Anywhere from 80% to 85% of the typical earnings of a wealth manager in any given year are based on the “new sales” she makes of funds like these to her clients. These new sales could be getting a current client to change funds or getting a new client and their money, referred to as net new money.
• The other 15% to 20% of compensation is the commission for the ongoing assets under management of the wealth manager.

This incentivizes the wealth manager to do 2 things: chase new money all the time and convince current clients to change their fund holdings. None of these are in the clients best interest.

What is in the clients best interest is actually the opposite of what the wealth managers are incentivized to do: stick with a strategy long term. Adjust as little as needed based on your plan to avoid taxes and trading costs and keep their money in the lowest cost funds in terms of ongoing investments.

If the wealth manager just made a fixed percentage of your assets at less than 1% and helped with the other facets of your life like goal strategy, estate planning etc. then they would, in my mind, be justified in earning more of their fee. This isn’t what Wall St. likes though, they would rather get the hustle money from the suckers.

What’s worse is that the more money you have, the more you can negotiate so that those with the least money end up paying the most due to economies of scale. Just take a look at the fees paid based on assets under management (AUM).

Source: advisoryhq.com

It Doesn’t Have to Be This Way

Luckily there still may be hope for my career plan as well as for those that want the services of an honest wealth manager.

A fiduciary wealth manager has a duty to act in their client’s best interest, even if it is contrary to their own. According to the SEC, fiduciary duty is defined as:

• Acting with undivided loyalty and utmost good faith
• Providing full and fair disclosure of all material facts, defined as those which “a reasonable investor would consider to be important”
• Not misleading clients
• Avoiding conflicts of interest (such as when the advisor profits more if a client uses one investment instead of another or trades frequently) and disclosing any potential conflicts of interest
• Not using a client’s assets for the advisor’s own benefit or the benefit of other clients

Unfortunately none of the large banks or wealth management brands seem to follow this model other than maybe Vanguard, which operates as a non-profit: the customers are the owners, any excess earnings go back to them.

I did manage to find a list from 2014 of a ranking of 100 fee only advisors here curiously enough, I noticed very few if any of them are in the New York area. I find this funny since New York is logically one of the top wealth management client centers in the entire world. It may be that the large money managers have too strong of a grip on the tri-state area and can stifle any competition. In other regions their may be a healthy skepticism of large financial institutions.

Another reason so many are not found in NYC is that NYC has more of the family office style wealth managers. Fortunes so large that they just operate as small independent managers themselves under the umbrella of a larger organization.

Either way, I am a bit relieved to see there is another way which wouldn’t entail me ripping people off to follow my interests. The journey will continue, just maybe not with a large institution.

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