posted on: 10/5/2006     revised: 3/9/2010

The National Association of Personal Financial Advisers (NAPFA) may be doing a disservice to investors with its new "Focus on Fiduciary" campaign.

Previously NAPFA was criticized for focusing on "comprehensive financial planning".  There is no denying that comprehensive financial planning is best for both consumers and planners, but the fact is that the majority of today's consumers do not want comprehensive financial planning.  Most people want occasional help with specific topics rather than ongoing input into all their financial issues.  For example, a person approaching retirement might seek help from a financial adviser projecting income and cash flow from retirement plans even though this person has been comfortable handling the management of the retirement plan for many years.  Considering the past history of self-managed investments, it would be inappropriate to suggest that the retiree now needs comprehensive financial planning that includes investment advice or management.  By embracing only the comprehensive planning approach, NAPFA ignores the service that the majority of consumers request.

Now NAPFA is focusing on the fiduciary issue that was resolved by the Securities Exchange Commission issuance of the policy that came to be known as the "Merrill Lynch Rule".  In short this says hat financial salespeople are primarily working for the benefit of their employer no matter what they call the service that they sell to investors.  Again, there is no argument that using an adviser who is a fiduciary  is better than using an adviser who is paid commissions and fees for selling products and conducting transactions.  But this campaign ignores the fact that the majority of fiduciary advisers are using asset-based fees that cause an equally objectionable conflict of interest.  While the name is different, asset-based fees have the same effect as commissions.  Many consumer advocacy groups have concluded that asset-based fees are inferior to other types of advisory services like hourly-based fees.  Asset-based fees create a financial incentive for the adviser to gather and retain client assets, regardless of the best interests of the client.  Clearly it is a different kind of conflict of interest, but still a conflict of interest nonetheless.  In addition to the conflict of interest created by asset-based fees, the issue of overcharging for services.  A typical asset-based fee is about 1% of assets per year.  The SEC recently outlawed charging a 1% annual fee to large mutual fund purchasers (called a 12(b)(1) fee) yet the same 1% per year charge is still legal when used by a fee-only financial adviser.   Asset-based fees are usually much higher than hourly-based fees and require little effort to ensure an ongoing income for the adviser.  As a result, more advisers have switched to asset-based fees to boost their income. Total fees (asset-based charges plus trading commissions plus internal fees of investment) easily exceed 2% on most investment portfolios using this method of compensation.  The adviser's compensation reduces the investor's net return dollar for dollar.    The bottom line is that asset-based fees make it impossible for an investor to maximize her net worth and virtually ensure that the financial adviser is over-paid for the service that is provided.  To treat asset-based fee advisers and hourly fee advisers in the same public relations campaign about fiduciary responsibility awareness is great for the asset-based fee advisers but is a disservice to investors. 

Essentially the NAPFA campaign is saying "look at us; we are the good guys...even the SEC says so...".  Such marketing ignores the other equally troublesome issues of asset-based fees.  NAPFA is unlikely to address the issue of asset-based fees since the large majority of its members use this method of compensation.  A switch to hourly fee method of compensation, for example, would reduce members' collective income by millions of dollars.

I suspect that at some time in the future the SEC or other regulators may distinguish asset-based fee advisers from hourly fee financial advisers for the sake of investors, but for now both asset-based and hourly fee advisers are on the same side of the fence as far as the Merrill Lynch rule goes.  For now, investors must rely on third party sources like consumer advocates, "Consumer Reports", the AARP and writers like me to point out that asset-based fee advisers might actually be wolves in sheep's clothing.

keywords:   NAPFA fee-only financial planner fiduciary hourly asset fee

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Copyright 2010 by Tony Novak. Originally produced and published for the "AskTony" column syndication prior to 2007. Edited and independently republished by the author in March 2010. All rights reserved.