At a recent talk that I gave I was asked a question about commissions. I explained how they work and why I don’t like them. At that point another attendee disagreed with me and explained that he worked on commission selling new cars and he thought there was nothing wrong with that. To his amazement I agreed with him. However, what I explained was there is a big difference between a car and a financial investment. When you purchase a car you realize there are a variety of parts and components that go into the car. In reality you don’t care what they allocate to the tires, the steering wheel or the electronics. What is important to you is what the bottom line cost of the car is. Therefore, when you negotiate your focus is exactly where it belongs, on the price of the car. Financial investments are another thing.
When you purchase an investment product with a commission, what that means is that money is coming out of your pocket and is put into other peoples’ pockets It is important as an investor to remember that if you want to get the highest returns possible, you must focus on costs; consequently, commissions are a substantial cost including the person who sold you the investment. . For example, if you buy an upfront commission mutual fund it’s not unusual for you to pay over five percent in upfront commissions. What that means is that if you invest $50,000 and there is a six percent upfront commission it means that $3,000 is deducted off the top to pay the commission. That’s bad enough; however, what you also have to factor in is that you now only have $47,000 invested. If you went commission free you would have $50,000 invested. Particularly for a long-term investor, that gap is substantial.
My point is that commissions on financial products can severely erode your returns. What further complicate things is the fact that there are all sorts of different ways that they can charge you commissions and unfortunately, they don’t make it easy for you to know what you’re paying. In fact, that’s one of the reasons I don’t like commissions, because they are not disclosed in a simple and understandable way. My belief is the fact that they don’t want to make it easy for you to know what you’re paying is a sure sign you’re paying too much.
Don’t get fooled when financial salespeople such as annuity people tell you that you don’t pay them, the company does- this is just an attempt to fool you. It may be technically correct but it’s not the whole story. For example, in annuities you are actually paying the commission in the form of higher ongoing management fees and substantial penalty periods which directly impact your returns.
I’ve always believed that the best commission salespeople never worry about their commissions; rather, their goal is to take care of their client. However, unfortunately, there are not as many good commission salespeople as are those who worry about their commissions first and foremost as opposed to putting the client’s interest first.
My philosophy in investing is that it’s always important to control your cost and to control your cost you have to know what they are. If you’re using a financial person who works on commissions, it is a fair question to ask them about their commissions and all the fees involved. If they’re hesitant or reluctant to discuss those things with you, it’s probably a clear sign that you should be dealing with someone else.
If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.