A fee-based investment is a type of financial opportunity that structures the compensation to the financial advisor based on the assets held by the client, rather than a commission that is collected on each transaction conducted on behalf of that investor. Depending on the financial circumstances of the investor, a compensation of this plan can be significantly more cost-effective than the more traditional commission approach. As an added incentive, there is much less potential for brokers or dealers to engage in what is known as churning, if the compensation is based the value of client assets rather than the number of trades conducted.
With a fee-based investment approach, the terms will call for the broker or advisor to receive compensation that amounts to a specific percentage of the client assets that are managed in the investment account. This approach encourages the broker to work with ways to secure investments that ultimately benefit the client and make it possible for that broker to earn more from the increased wealth of that client. Since the focus is finding and securing the best assets and less on using intricate buy/sell strategies that involve multiple transactions, the advisor will want to help the client choose holdings that keep the investment account consistently increasing in value.
The financial benefit of a fee-based investment strategy extends to both the client and the broker or advisor. Clients will often find that brokers focus more on trades that are likely to continue generating revenue over the long term, a factor that helps to strengthen the financial positions of those clients. Brokers in turn can engage in activities that incrementally increase the worth of the client’s account, which in turn means consistently greater compensation.
Another key benefit of the fee-based investment approach is that it helps to minimize the potential for what is known as churning. Churning is an ethically questionable practice in which an advisor is constantly making transactions on behalf of the client in order to ramp up more commissions, earning something off each of the transactions placed. This type of over trading can undermine the relationship between a broker and the client, while also limiting the returns that the client receives. Since a fee-based investment approach means the broker does not make more unless the value of the investment account increases, there is no need to engage in a series of trades that are not really necessary or in the best interests of the client.