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During the last few years, financial firms and professionals have become enamored with generating fees as opposed to commissions. The thinking goes something like this: let's gather assets and then charge an annual management fee. This will insulate our revenue stream from down markets because we will have this continuous revenue. We have seen our commission revenues drop during past bear markets and this must be the answer.
But the distinction that by changing the way we charge clients will alter the revenue stream is false. This is not widely recognized yet, because we have not experienced a bear market since this mania to fee-based accounts has gained momentum. Do you think that clients will willingly pay your fee each quarter when their account value keeps declining? For this reason, a fee revenue stream is even riskier than a revenue stream based on commissions. Clients will in fact be as fast to close their accounts whether they have been charged a fee or commission.
Let's take an example. I am old enough to have experienced a real bear market in the fall of 1987. I was working on a commission basis in a securities firm. I opened more new accounts during that quarter and gathered many new clients. This success is counter to the traditional wisdom that commissions business dries up during a bear market, as it does for most advisors. Why?
Because the average commission-based advisor is selling a product that depends on its public attractiveness. In other words, if you are a stock pusher (a stockbroker), during a bear market, your sales dry up. How do your avoid this? You cease your product orientation, i.e. selling stocks and employ a client orientation, i.e. sell what people want.
In the last quarter of 1987, equity buyers were shell-shocked. It was obvious to me that they were not going to want stocks, but the conservative nature of bonds (many of which paid 10-12% then) would be very attractive. So I eliminated the word stock from my vocabulary and became a bond salesman. I sold millions and millions of Safeway bonds at 11.75%. The beauty of being in retail financial sales is that you have a product readily available for any market. You always have a product that the public wants. If inflation rears its head again, you can make a fortune selling gold stocks and gold mutual funds. If deflation occurs, long term, high quality fixed income instruments will rule.
The challenge is to realize that your job is NOT to sell product. It's to determine what the public wants. When you do that successfully, fees vs. commissions becomes an irrelevant issue. The public does not buy from you based on how you charge. They buy from you when they see more value in doing business with you than not doing business with you.
Therefore, the idea that fees or commissions are a determinant of your personal business success or your firm's success is false. This will become obvious during the next bear market when everyone has jumped on the fee-based wagon thinking it's the panacea to the ups and downs of the markets. Clients will become dissatisfied with their returns and close their accounts. Then you'll be stuck in your fee-based/equity-based mind set with no way to generate new revenues.
Let's look at the evidence. Mutual funds are fee-based accounts. How long does the average client own them? Here's a quote from Dalbar's study of fund investor behavior:
"Despite the proliferation of educational materials and media coverage regarding the benefits of holding mutual funds for the long term, the average investor still holds their funds only 3 years, the same as in 1984."
I might add that since 1984, we have seen an explosion of no-load fund offerings--pure fee-based opportunities. Yet, investor behavior has remained the same: they are fickle and impatient and run their portfolios by emotion.
Once we all realize that, the distinction of how we charge the client will fall from the limelight. We will turn our attention to the messy psychological core of this business: how to master client-focused, emotionally-centered marketing.
http://www.dalbar.com/quantitative_analysis.shtml
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