Understanding the compensation structure is an essential part of deciding which broker-dealer investment firm to join. It is undoubtedly important if you are a newly minted financial advisor looking for a firm. The compensation structure is also crucial if you’re ready to leave your current firm and are searching for a better payout.
Fees
First, let’s look at where the fees originate. The firm may charge the client a commission on the sale of mutual funds and other financial products. The firm might levy a client management fee based on a percentage of assets under management (AUM). Or the firm might do both. The gross fee charged to the client is then divided between the firm and the advisor.
The firm’s portion of the fee goes to cover the overhead of the firm. Overhead includes Securities Investor Protection Corporation (SIPC) fees, the company’s technology platform, office expenses and any other costs of running the business.
However, not every firm pays out the same percentage to its financial advisors.
Flat Advisory Administration Fees
Advisors who manage their clients’ assets themselves often pay 10-30 basis points on client assets for billing, statements, and performance reporting. More broker-dealers are opting to do these functions themselves rather than through a clearing firm. As such, they’ll usually charge between $25-$55 per account annually instead of charging a percentage of assets.
The new per account fees usually provide significant savings over the fees based on AUM. It allows advisors to keep more for themselves and their clients. Another bonus of per account fees is the use of Orion, which is known for its high accuracy.
Markups on Outside Money Managers
At larger broker-dealers, you will often find a 10 to 25 basis point markup on management fees for a third-party money manager. Advisors are not always aware of this markup, and broker-dealers rarely wish to volunteer the information. It follows that advisors should ask their broker-dealers about the fees.
Friendly to Direct Holdings
Broker-dealers are increasingly focused on getting assets into brokerage accounts.
Some broker-dealers have tried to reduce the costs of holding assets in a brokerage account. They may not charge fees for systematic withdrawals/deposits, dollar-cost averaging, or even U.S. stock trades on some accounts.
Inactive account fees and Individual Retirement Account (IRA) custodial fees are still commonly incurred in brokerage accounts. Financial advisors need to seek out broker-dealers who will not twist their arms to put all their assets in brokerage accounts.
Errors and Omissions Insurance
Most broker-dealers require advisors to purchase their Errors and Omissions Insurance (E&O) through the broker-dealer’s group plan. Typically, broker-dealers will treat E&O as a profit center and mark it up. Annual costs of $3,000 or more are now common. Deductibles are usually in the $10,000 to $25,000 range. In the past, deductibles were typically around $5,000.
E&O rates and deductibles may be even higher if an advisor invests in particular assets. Making substantial investments in REITs, Business Development Companies (BDCs), or alternative investments can increase charges.
However, some broker-dealers allow their advisors to buy their own E&O insurance. It is much cheaper without the broker-dealer’s markup. With a good compliance history, an advisor with a Series 6 license who only invests in ETFs, mutual funds and variable annuities can usually get E&O coverage for much less.
Broker-Dealers Offering the Big Bucks
Payout ratios for firms are all over the map, and ratios within each firm likely vary across product types. The following is a list of the broker-dealers with some of the highest payout ratios in 2019. A range in the payout ratio column means the ratio varies depending on a variety of factors. The complete list with the fee range across all asset types can be found at Financial Planning.
Source: Financial Planning.
The Bottom Line
For financial advisors, the payout ratio is important when choosing between broker-dealers. However, the payout ratio is not the only metric to consider. It is also wise to look at corporate cultures and work metrics when choosing a broker-dealer.