Investors wary of a broker’s self-interest in selling commission-based products may look to change to a fee-based advisory account. Rather than charging a commission for each transaction, fee based accounts typically charge an annual fee based on total account value.
However, while a broker might “churn” an account in commission situations by inappropriately purchasing securities to drive up personal profit, the SEC is increasingly concerned about “reverse churning” – where an advisor neglects making appropriate periodic reviews and recommendations for a fee-based account. Since the fees are charged regardless of activity, advisors have a lack of financial incentive to take the time to review accounts. Crunching the numbers, for an investor holding a lot of cash or cash equivalents, or with little active trading annually, a fee-based account might be significantly more expensive than a brokerage account and without additional value. Paul Meyer, a principal at the Securities Litigation & Consulting Group Inc (SLCG) offers up this $100,000.00 example:
An investor with a $1 million portfolio trading $100,000 in securities per year who pays the equivalent of 1 percent in commissions would have nearly $1.47 million after five years, assuming an 8 percent return. The same investor, in a fee-based account who pays a fee of 1.5 percent of the portfolio, would have $1.37 million,
See the full article for Meyer’s example and all of the SEC concerns about reverse churning here.
Registered investment advisors overseeing fee-based accounts have fiduciary duties to their customers, and neglect of an account while charging an annual fee can be a breach of those fiduciary duties in violation of the law.
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