Most clients have heard the term commission, but they may not know what it really means for advisors.
They likely get the basics – that you get a percentage fee for selling products. But they’ll need clarification on the details associated with commission-based compensation, such as the differences between various mutual fund commission structures, trailer fees, redemption fees and surrender charges.
Here are some questions your client will probably ask, and how to answer each.
Q: How much commission do you charge?
A: The commission I receive varies based on the product you’re purchasing and the amount you’re investing. For instance, if you invest $20,000 into a mutual fund and I charge 3%, my cut is $600 and the rest is invested. But if you’re purchasing a GIC, I don’t receive any commission — just a finder’s fee from the bank offering the product.
Q: What is the difference between front-end- and back-end-load fees on mutual funds?
A: A front-end-load is a one-time fee that you’re charged when you buy the fund. It’s a percentage of your investment and is paid to the investment firm that’s selling the fund. I also receive my commission up front when you purchase the fund.
Meanwhile, a back-end-load, or deferred sales charge, is a fee that’s paid when you sell the fund. It’s based on how long you hold it, and the fee declines on a fixed schedule. If you sell a back-end-load mutual fund before the end-date, you’ll owe exit fees.
Q: What are service fees?
A: Also called trailer fees, this is an annual commission I receive from fund dealers for selling their products and providing advice to you on an ongoing basis. Back-end trailer fees are generally around 0.5%, while front-end trailer fees are typically around 1%. Funds that pay me trailer fees generally have higher management fees, which is the annual fee paid to a fund manager (not to me).
Q: What benefit do I receive for paying commission rather than going through a fee-based advisor?
A: It can be cheaper for you. If I were to charge an hourly rate, that could add up quickly, whereas commissions are generally one-time fees. Also, I’m connected to fund dealers and managers, and this means you have more investing options.
Q: What is the incentive for you to charge commission rather than fees?
Receiving commission makes me more motivated to find products that are right for you. I have a relationship with fund managers and dealers that I need to uphold, as well as a relationship with you, so there’s accountability on both sides.
And, quite honestly, I’m eligible for incentives like higher trailer fees from fund dealers for good performance. But my focus is on choosing the right products for you, and having a direct relationship with the fund dealers helps make that possible.