Why should a financial "advisor" be paid if their client experiences losses?

In the past the argument against compensating brokers with a portion of their client's gains was forbidden because it was thought that it would encourage churning accounts in a frenzy to generate large returns.   Since most of today's "advisors" do little more than shove their client into a mutual fund family with a sales contest going and then tell them to hold on for the long run why not compensate them with a percentage of the fund's gain?   There is much made about the client and "advisor" being teammates, partners.  But unless the "advisor" stands to suffer when the client suffers it's not really a partnership at all.   If an "advisor" is worth their fees they should be willing to accept nothing from the client unless the client's return exceeds a minimum expected rate of return.   Telling your client, "I won't make a dime unless you earn at least 5%" is a hell of a lot more honorable than telling them, "I"m going to suck 1.5% out of your account every year even if you're losing."

Telling your client, "I won't make a dime unless you earn at least 5%" is a hell of a lot more honorable than telling them, "I"m going to suck 1.5% out of your account every year even if you're losing."   So in other words, I should take my conservative clients and make sure that they invest aggressively.   My job isn't to maximize returns for my client.  It is to make sure that my client maximizes their chance of reaching their goals.  It's not the same thing.

Putsy,

  None of my clients have goals that have to do with a rate of return.  My clients have goals that are things like:   "I'd like to send my child to the best school that accepts them." "I'd like to retire comfortably at age 65." "I'd like my family to maintain their same standard of living if I die today." "I'd like to not be a burden on my family if I need care when I get older."   Your idea stops the advisor from being a partner with his client.  It encourages the advisor to invest above the client's risk tolerance.         

Which of those goals is not more easily realized when the client experiences a positive rate of return instead of a negative rate of return?

  What does having you as an advisor have to do with their child's ability to get into a good school?   I can assure you that retiring comfortably at 65 will be easier if the return is greater.   Life insurance takes care of number three.  I am not suggesting that one should invest for maximum return instead of buying insurance.   It is far easier to not be a burden on your family if you have an "advisor" who knows how to maximize the return you are able to generate instead of establishing below average goals and then boasting that they were achieved.  

"Which of those goals is not more easily realized when the client experiences a positive rate of return instead of a negative rate of return? "

  Putsy, every goal is more easily realized when the client experiences a positive rate of return.   That misses the point.     Under your "plan", if I lose 20% for my client one year and then make 30% for him the next year, I make more money than if he makes 4% each year, yet he is in worse financial shape.   Additionally, if we invested above his risk tolerance, he may bale out of his investments and not make the 30% then 2nd year.    "What does having you as an advisor have to do with their child's ability to get into a good school?"   Work on your reading comprehension.  The goal has nothing to do with getting into a good school.  It has everything to do with being able to send the child to that school.   I can assure you that retiring comfortably at 65 will be easier if the return is greater.   You absolutely can't assue this if the greater return comes with greater volatility.  Joe and Sam each have $1,000,000 and need $3,000 a month to live comfortably for the rest of his life.  Joe's investment gives him 3.6% every single year.  Sam's investments average 5%, but with great volatility.  Sam's investments take big drops during his first two years of retirement.  Sam ends up broke.  Joe gets his income every year and he leaves his family $1,000,000 at death.   Life insurance takes care of number three.  I am not suggesting that one should invest for maximum return instead of buying insurance.   It is far easier to not be a burden on your family if you have an "advisor" who knows how to maximize the return you are able to generate instead of establishing below average goals and then boasting that they were achieved.   Who establishes below average goals?  People establish the goals that they want to achieve and are realistic.  Going after high goals can lead to disaster.  Ex. The client wants to retire at age 65.  They would love to have $15,000/month of income.  They only need $7000/month to be comfortable.   Investing in a fairly conservative manner will allow them to be comfortable.  In order to have $15,000, they will have to take a ton of risk and underdiversify and hope to get lucky.  Oops, it didn't work out.  "Sorry, client, we failed at your high goal.  Now, you can't retire."   This isn't life where you reach for the stars and if you fall short, you land on the moon.  This is more reaching for the stars and if you fall short, you end up in worse shape than you started.   If a fiancial goal is easily attainable, increased risk decreases the chance of success.  If a financial goal is difficult to attain, increased risk increases the chance of success, but it can come at a cost that isn't worth paying.

For those who are following along.  Google opened in the 370s and almost immediately traded up to about 382.

  At that point the bull put spread narrowed to 3 1/2 so I covered five of the twenty spreads.   After that the stock traded down into the 360s and the bear call spread narrowed to 4 so I covered five of them.   The resultant gain in the five that are now closed is just shy of 1.75 so I've reduced yesterday's closing risk of a bit more than $1,000 to about $200.   Right now the stock is trading at 372--almost dead solid perfect to capture the $14,000 and change that is still on the table waiting to be picked up.   Yesterday somebody referred to the idea as a "zany options strategy."   It started out as no more than a $1,000 potential loss, is now a no more than a $200 potential loss and a possibility of making as much as $14,000 in a single day.   That's the kind of zaniness that clients envision when you hand them your card.  They don't anticipate paying you to give them an annual report, a birthday card and a hamburger or two at a BBQ on the office parking lot some spring evening.   Be honest with them, ask them if they're happy with their portfolio and your "advice."

What character flaw are you displaying when you assume that speculating with 15% of your money will result in a loss of 100% of your money?

  I'll ask again.  What would be wrong with you earning zero in a year when your client earned also earned zero?   Would you be willing to accept an agreement that gave you the first two points above 5% to the client.   If the client doesn't earn at least 5% you don't get paid a single penny--but if they earn 7% or more you get paid 2%.   I bet you'd have to fight them off with a stick.

That’s the kind of zaniness that clients envision when you hand them your card. 

  They can envision what they want when I hand them my card.  However, when I open my mouth and tell them what I do and how I work, they realize that this isn't what they are going to get.  The value that we provide our clients is not in picking the best investments.  If we could do this, we wouldn't need clients.    You come one here and talk about your great trades.  Yet, it's obvious if you were so good at investment picking, there would be another zero or 2 zeros on the end of the size of your trades.  We're not investment pickers.  We're financial advisors.  If I knew what was going to happen in the market, I'd borrow and invest and be very wealthy.  I'm quite comfortable with my lack of knowledge as are my clients.    By the way, I will make more than $14,000 today and it doesn't matter what happens to Google.

I am unable to cut and paste responses.

  I do not have clients, per se.  I manage my own account and some money for my brother.  My arrangement with him is that he will give me a Christmas gift that reflects how well I did for him during the year.   I've gotten a gag gift of a lump of coal and also tickets for two on a cruise ship called The Silver Wind from Montreal to New York--with him and his wife along to share the experience.  Google Silver Wind to see what it's all about if you don't know.

I'll ask again.  What would be wrong with you earning zero in a year when your client earned also earned zero?   Would you be willing to accept an agreement that gave you the first two points above 5% to the client.   If the client doesn't earn at least 5% you don't get paid a single penny--but if they earn 7% or more you get paid 2%.   I bet you'd have to fight them off with a stick.   I'd be willing to accept this arrangement in a heart beat.  My client on the other hand would be a fool to accept this arrangent.    It encourages the advisor to invest in a way that ignores the client's risk tolerance, time horizon, and financial goals.   In fact, it would make my life much easier because everyone's money would be invested in the same manner because there would be absolutely no reason to take anyone's risk tolerance, time horizon, and goals into consideration.    What it really would do is to change my occupation from financial advisor to money manager.     

What is the profile of a client who engages a “financial advisor” with the goal being to generate a return of less than 7%?

  Again, your reading comprehension is failing you.  People don't engage financial advisors with goals of getting a set %.   We can do absolutely nothing to increase their rate of return and still add value.   Here's an example from earlier this week.   Nothing that I did is increasing their rate of return.  We did the following:   1) Purchase term insurance from outside of work instead of inside of work 2) Supplement their DI coverage 3) Changed how they were making debt payments.  They will now make minimum payments on everything except their one credit card with the highest interest rate. 4) Increased their Roth IRA contributions   I was born late one night, but it wasn't last night.  I've been around this world since the early 1970s and know that anybody who is going to earn $14,000 today as a financial "advisor" is way to busy to waste their time on an internet message board.   It doesn't take too much time to put $400,000 into a SPIA.

How about if it was "conjured up" on Monday from an existing client and the check arrived on today?  We don't make money today from the work that we do today. 

It's not like this is some giant impossible to believe event.   

Gotta side with Put on this one. Not so much for the one liner put downs of what I perceive as hard working well intentioned advisors, but with what the financial advisory business has become. Going back to Put’s options trades he’s exactly right. Whether these trades actually work is not relevant. It is that he is executing a well thought out investment strategy. Done enough times and a track record will emerge. That record will tell him whether he is on the right track, whether he should modify his approach or just plain stop. Included in his strategy is a stop loss, 15 or 20%. That’s as good as it gets. How many here have stop losses on their clients accounts?

  Turn the clock back 25 years and Wall Street was filled with advisors coming to clients with their money making strategies. Some were short term high risk, others long term low risk. Brokers, as we were known then, employed options strategies not unlike some mentioned here, others like myself offered buy write strategies and dividend roll programs, now called dividend capture and employed by some of the biggest funds in the world today. Back then, we did it ourselves.   Prospective clients had a real choice when picking a broker. Today, for the most part, that choice is gone. I'm not saying anyone here is a bad guy. It's just most in our biz are the same guy. Some are better at this than others but basically most advisors offer the same thing. What our industry offers is off the rack cookie cutter planning, execution,  management, and product selection. We slap a fee on it and call it good. It is far from good.   Many here may not like the messenger, but you need to hear Put's messege because he is exactly right. There is no reason on this planet for anyone to pay you a fee to lose 40% of their hard earned money and offer them nothing more than investment platitudes.   His suggestion to find something you can be passionate about that seperates you from the herd should especially be taken to heart. Do something, do anything but don't just sit there and collect your fee.   It could be this simple:   Research 20 stocks. Pick any area you'd like. Become an expert on those stocks. Then pick 5 stocks, yes just 5. Put 20% of your clients equity portfolio in to each stock, with a 20% stop loss on each. Risk exposure to a bad pick is limited to 4%. Let me tell you something, 4% you can come back from. And if the entire prtfolio gets stopped out at 20%, that too you can come back from. Establish a strict sell policy. Whether that be at a certain profit point, or when certain financial screens tell it's time, it's important to establish a sell policy.   One strategy has a sell policy built in - Find dividend paying stocks and write short term calls against them. The buy write yield right now is off the charts. The high VIX is your friend in this strategy. This strategy gives your clients exposure to favorably priced stocks, an income stream and an alternative income channel. Now that's something worth paying for. Doing this for a fee elimates all the commission cost and makes even selling just out of the money calls a good strategy.   Regardless of what your strategy is or isn't, what Put is saying is being said in homes across this country. If anyone thinks their clients are down with losing 40% in a year and giving up 5 years of gains, well they are partially right, their clients are down.    Find something that works for your clients, get passionate about it, and you will be worth every penny.