My Broker Said, "I Make Money When You Make Money"

This is the standard method by which the large Investment Houses sell their "Wrap Fee" representation.  [More on "Wrap Fees" here: Wrap Fees.]

The basic idea presented to you, the potential client, is this: My firm will charge you a certain percentage of your total account value (generally 1-2% per annum) for ALL of our advice, custody of assets, account protections, glossy brochures, endlessly deforesting junk mail and Special Client Wine and Cheese receptions.  Therefore, the thinking goes, in order for us to make more money, it is in our interest to make darn sure we provide the advice and services necessary to GROW your account.  Hey, you have more, so we make more!

This puts us both, Mr. Potential Client, "on the same side of the table".

 

Wow, where shall I begin?

A.  If you are considering entrusting any funds, for any reason, at any time, to someone who must assure you that he or she "is on your side of the table", run, do not walk, to show him or her the door.  What is the alternative-that the person whom you are paying to manage your money stands at some variance to your best interests?  Should we also hire mechanics to wreck our cars or Doctors to make us sicker?

B.  Just as the old joke about Lawyers goes, when your broker is saying anything, make sure you have both hands on your wallet.

C.  The statement itself, "I Make Money When You Make Money", is technically true, as far as it goes.  A more forthright explanation of the proposed arrangement would be, "I make money (1-2%) when you sign the account papers, and I'll continue to draw that percentage from your account unless and until you close your account with me.  It will not matter whether the account value remains flat, diminishes or grows, I'll continue taking my percentage."

 

Now, let us assume that you have fallen for the siren song of Mr. Edward J. Cashgrabber, Financial Advisor and First Vice President of [insert TARP Firm here].  Let us further assume that you have placed an even $100,000 in the account, and that "Fast Eddie" is charging you a fairly standard 2% wrap fee.

Now, Mr. Cashgrabber would have explained to you that it is in his best interest to do everything humanly possible to grow your account value, in order for him to maximise his income from your account.  Hey, 2% of a bigger account is more income, right?

Firstly, understand that you are down 2%, right out of the gate, by virtue of the fee having been charged.  Now, if Fast Eddie is interested in maximising his income (and you can be very sure that he is), will he be more concerned with making sure that his established accounts grow, or in getting more accounts?  The marginal income to him when his established accounts grow by, say 10%, is a mere 2% of the growth rate.  That works out to $200 for him IF your $100,000 account grows by 10%.  Recall, he netted 2% ($2000) when you signed, and will net 2% of the total account value until you leave.  I'll wager his next beamer payment that he's out chasing new accounts, and keeping you just happy enough to stick around.  (And so will he.)

FSBWinchester Asset Management: Speaking Truth to Power Since 2009.

 

Respectfully,

Robert C. Broderick, Jr., Esq.

Principal