When you buy a car, you don’t demand to know the size of the salesperson’s commission. So, why would you demand to know the commission your financial advisor gets?Most other arguments the mutual fund industry uses are easily refuted (see Tom Bradley’s excellent article on this subject). However, this car analogy rings true at first. I don’t worry about how much commission the car salesperson gets. It’s the total price of the car that matters to me.
The problem here is that the analogy isn’t an exact fit. For example, almost everyone is aware that car salesperson commissions come out of the car price. Many investors don’t know how their financial advisor gets paid. But the differences run deeper.
Let’s imagine a fictitious world where car ownership more closely matches mutual fund ownership. Suppose that instead of paying car salespeople from the car’s price, car companies sneak out in the middle of each night and siphon a few dollars of gasoline from all the cars they’ve ever sold. The car companies resell this gas to pay salespeople commissions and their own salaries. Many car owners aren’t aware that gas siphoning goes on, and even when they hear about it, they don’t believe it’s happening to them.
All this may sound absurd, but it is a close analogy to how most mutual funds work. The management company takes cash out of the funds each day to cover all costs including financial advisor commissions. There are some mutual funds that don’t pay financial advisor commissions, but most do in Canada.
In this fictitious world, it would be perfectly reasonable for car buyers to ask salespeople whether they are paid from surreptitiously-siphoned gas. They might also ask whether salespeople recommend cars based on their cut of the gas siphoning.
Getting back to the real world, it’s true that mutual fund investors should be concerned primarily with total costs rather than just their financial advisor’s cut. But, in most cases, investors’ only contact is with their advisors, and mutual fund companies are paying advisors to make them insensitive to the total fees of the mutual funds they recommend. The problem is not just the hidden costs of financial advice, but the inflated costs not associated with advisors.
If we cut off the flow of money from mutual fund companies to advisors, this will remove the incentive of advisors to choose expensive mutual funds for their clients. This will force more mutual fund companies to compete on costs, which will be very good for investors.