Fixing compensation

Lefeaux is not alone. All 360 planners polled for the IE Planners’ Report Card are compensated on a transaction basis, yet the idea of fee-based and fee-only planning is on the minds of many. Although compensation type was not directly addressed in the survey, many planners brought it up. They are aware of pressures in the market that make transaction-based planning less viable, and are considering alternative forms of compensation.

According to Lefeaux, ‘there are fewer clients coming in the door,’ so the frequency of trades is declining. That’s bad news for a planner who depends primarily on sales commissions.

At the same time, competition from banks is forcing down the size of the commissions. Clients are expecting lower management expense ratios from mutual fund companies, and planners are coming to expect lower commissions from deferred sales charges. Where dealers used to make 5% on a DSC (down from 9% just a few years ago), there is pressure to kick back a large chunk of the commission to the client.

‘The volume is down, plus the commission per trade is down. Interest in trading is down. And more clients are doing their own transactions on the Internet,’ Lefeaux says.

Competition intensifies

And there’s competition from bank-owned discount brokerages such as TD Green Line Investor Services Inc. and Scotia Discount Brokerage Inc. Discount brokerages now pay half the 5% DSC commission to the client, investing it in the client’s mutual fund account. Clients now expect similar discounts from planners.

‘To the broad-range, comprehensive financial planners like ourselves, that is a threat,’ Lefeaux says. ‘The perception by the client is, ‘I should be able to get the same mutual fund for nothing and you should be able to pay me to buy them like the banks do, and give me a bunch of free excellent advice, too.’ Well, we can’t do that and stay in business.’

But a 31-year veteran securities dealer and financial planner in southern Ontario says he has difficulty collecting a full DSC commission in an environment where discounts are prevalent. ‘How in the hell can I sell somebody something and charge a commission when I know they can get it free?’ he asks. ‘I don’t feel right about it.’

In the meantime, transaction-based planners such as Lefeaux are looking for new ways to offer clients financial services that are worth paying for. One way is to move out of the sale of mutual funds and into wrap programs, where clients pay a percentage of total assets under management – usually 1% to 1.5%, depending on the size of the account. Another alternative is to move into the realm of broader financial services.

‘I’m moving away from mutual funds, which are becoming commodities, and toward estate planning using universal life insurance as a savings tool,’ Lefeaux says. There’s less competition in this area, he says. There’s also more room for advice and, presumably, justification to charge for it.

For example, universal life products provide a death benefit as well as a savings component, which can grow tax free. ‘We can do a lot of exciting planning things with it we can’t with an old-fashioned RRSP.’

But the issue of transaction-based, commission-based and fee-only planning is as much a matter of semantics as it is of compensation.

According to Terry Taylor, executive director of the Canadian Association of Financial Planners, it’s difficult to tell whether there is a trend toward fee-based planning as the definition is often unclear.

A fee is a fee

A fee based on assets under management is called a fee, he says. But, because such a ‘fee’ is a percentage of assets, it should, by definition, be called a commission.

‘You have to distinguish between fees that have to do with the sale of a product and fees that are representative of an hour’s worth of work.’

There are three basic methods by which financial planners are compensated: by transaction-based commissions on products such as mutual funds; by asset-based annual commissions on products such as wrap programs; and through flat or hourly fees for service, often referred to as a fee-only service.

Taylor estimates between 10%-15% of CAFP members fall into the fee-only category (by extension, that category makes up about 5% of the industry). He can’t say how the remainder is divided, partly because there is considerable overlap: many planners charge a fee for devising a financial plan, then receive a commission for selling the products.

So when is a commission a fee, and when is a fee a commission?

‘We’ve chosen as an organization not to go down that road. We have a section of our code of ethics that says – call them fees, call them commissions, call them whatever you want – you have a duty to disclose all sources of compensation to the client, regardless of how it’s derived.’

Another consideration in the fee-vs-commission discussion is the issue of the public’s trust.

Taylor believes the public should have no reason to doubt the motives of transaction-based planners. When advice to buy a certain fund comes from a transaction-based planner, the client might suspect the planner’s objectivity. Yet when the same advice comes from a fee-only planner, it is often accepted as unbiased advice. The problem lies with the public’s perception, not the planner’s ethics, he insists.

Lynne Triffon, senior financial planner at R.M. Paterson and Associates Ltd. in Vancouver, is a fee-only planner who believes competence and trust are the keys to a successful planner-client relationship – regardless of the compensation type.

‘The challenge is for planners to demonstrate to the public that they have the expertise and the ethics to manage the client’s money.’