Q15 – Does the client or RIA pay the trading transaction costs?

Also available as podcast (Episode #15)

Apple  |  Android  |  Spotify  |  Amazon

Does the client or RIA pay the trading transaction costs?

Depending on the product being used (stock, ETF, mutual fund, option, etc.) your custodian will perhaps charge a transaction fee for each transaction made (buy & sell).  By default, these transaction charges are usually charged to the client.  However, a Registered Investment Advisor (“RIA”) generally has the option to absorb these charges on behalf of the client.  However, creating this latter sort of “wrap” arrangement introduces a number of potential conflicts and disclosure requirements that need to be considered.

Found This Video Helpful?

Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice?  I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.

Full Transcript:

Does the client or RIA pay the trading transaction cost? That is today’s question on the Transition To RIA video series. This is question #15.

Hi. I’m Brad Wales with Transition To RIA. And today’s question is, does the client or the RIA pay the trading transaction cost? Now, I’ll start this video by pointing out my answer to this question today is quite a bit different than had I made this video a year ago or prior. I’m going to explain why that is. The world has fundamentally changed as far as transaction costs go in this past year or so. If you’ve last asked this question or been told an answer roughly a year ago or prior, things have definitely changed. This video addresses the new world environment that we’re in.

I’ll start by saying, what is a transaction trading cost or when does it occur? Let’s start by what it was a year or so prior, and then we’ll kind of look at how it’s changed now.

Up until about a year ago, every time you would place a trade in a client’s account, the custodian that you use to hold that client’s assets and facilitate the trades would charge a transaction cost. That was on every equity trade, on every ETF trade, every option trade, mutual fund trade. Every time you did a rebalance or you adjusted an account, every time there was a buy or sell, generally, there was a transaction cost on that buy and on that sell.

As an example, on an equity trade back in the day, you used to maybe pay – and it varied for a couple different variables or reasons – but perhaps your transaction cost that you had with your custodian called for a $7 transaction charge on every equity trade you did. Every time you bought or sold an equity, it was $7 on the sale, $7 on the buy. Mutual funds have different transaction charge price and options do. ETFs were usually lumped in the same pricing with equities.

Fast-forward to now, the world has changed, at least with respect to some of that. A number of custodians came out and said, “Hey, we are going to reduce the equity & ETF piece down to zero.” Then once the proverbial dam broke, then a number of other custodians fell in line. And so, most large custodians, not all custodians, but most large custodians now have kind of similar pricing on that zero.

Nowadays, if you were to work with one of the larger custodians, you generally will not pay a transaction cost for at least equities and ETFs. I’ll talk about the other products. So every time you do a buy or sell, what used to maybe cost $7 or $8 is now zero. Again, that’s kind of the industry norm nowadays. And that is a fundamental change from what it was not too long ago.

Let me point out that the headlines that came out around this was.…”Transaction costs, trading costs have gone to zero.” With respect to equities and ETFs, that is absolutely accurate. Again, assuming you’re working with one of these custodians that fell in line with that trend.

However, it is not to imply that all transaction costs went to zero. Equities and ETFs went to zero but generally speaking, all custodians still charge transaction charges on, among other things, mutual funds. Now, there’s a way to maybe avoid that transaction charge with respect to mutual funds, I’ll touch on that in a second. Option trades usually have some sort of component to it. Maybe there’s no flat amount upfront but there generally still is a per-contract charge that goes on that. Fixed income trades usually still have a transaction charge.

The point of this is to say transaction charges still exist with certain kinds of trading products or investment products. With equities and ETFs, generally no. But, again, mutual funds, fixed income, options, there generally still is a transaction cost there. That’s part of what we’re talking about here today is again, who pays that transaction cost?

Before I get into that, I did want to note a couple ways to further, in theory, avoid these transaction costs that do still exist. One way, with respect to mutual funds and to a degree at some firms still ETFs that…at some firms, have not gone to zero on ETFs.

Let’s start with mutual funds because this is pretty uniform throughout all custodial options, that generally speaking, by default, a mutual fund has a transaction charge. However, if a particular mutual fund you desire to use is on the custodian’s “NTF” list or No-Transaction-Fee list…a lot of firms refer to it as an NTF list. If the mutual fund you desire to use is on that list, then there will be no transaction charge with that. It will be zero on the buy and will be zero on the sell.

I would tell you, from the whole mutual fund universe that’s out there, give or take about 80% to 90% of mutual funds are generally on those NTF lists. The point is there is the chance that you will have to incur transaction charges on mutual fund trades. But in most cases….again, depends on the fund families you use. In most cases, they could be found on this NTF list, and it might be zero after all. But know there is that reality that there could be transaction charges on some subset of those mutual funds.

Then for some custodians that are still charging transaction charges on ETF trades, some of those firms also have a NTF ETF list. So…..”Hey, as long as you use these ETFs on this list, it will be at no transaction charge.” That’s not as prevalent as the mutual fund situation because, again, most custodians have gone to zero altogether on ETF. Just know that the NTF concept, in some occurrences, does apply to that ETF platform as well.

The last thing I’d say on how these charges can, I don’t want to say be avoided, but how they’re priced is most custodians will also offer an option often referred to as asset-based pricing, ABP. As opposed to everything I’ve just described, which is often referred to as transaction-based pricing, which is on a per-trade basis, what is the transaction cost going to be. Maybe it’s zero like we talked about or maybe there is that fee.

The idea with asset-based pricing is….”Hey, I as an advisor don’t want my clients to see any transaction charges, even if it’s only a subset of mutual funds and even if it’s only the few option trades I maybe do or the few fixed income trades. I don’t want any transaction charges.” That’s the idea of asset-based pricing.

I’ll do a whole separate video on transaction-based pricing versus asset-based pricing. So I don’t want to dive too deep into that here. But in concept, the idea is as opposed to paying these individual transaction charges on each time a trade is done, instead, there’s a basis point charged to the account. Maybe it’s three basis points. And for that, it’s effectively unlimited trading with no transaction charges. So, you might hear that, again, asset-based pricing.

I’ll do a whole separate video on the pros and cons of transaction-based pricing versus asset-based pricing. But I did want to point out that that is, in theory, an additional way to eliminate these transaction charges.

So, the question is…on today’s video, we’re talking about….if you are going to use this transaction-based pricing arrangement and yes, most of your trades might go at zero but there still could be some that don’t or do have a fee. So, question is, who pays for that?

Generally speaking, by default, it goes to the client. It is charged to the client’s account. There’s a host of reasons that’s arguably better than the alternative, which I’ll touch on.

The reason is because, as an advisor in an RIA environment, a fiduciary environment when you’re solely under the RIA umbrella, you are not receiving commissions for anything. You are solely receiving your advisory fee that you charge your client.

If you’ve had a client for a long time and maybe there was a time that you did work in a commission capacity with them, they’re familiar with the idea that every time a trade was done and a commission was generated, that is part how you were compensated.

If you do have clients that have been with you through both of those cycles of how commissions versus fees was occurring….now all of a sudden, if you start your own RIA and you’re with a custodian and your client sees these transaction charges, they might be confused because they say, well….”Mr. or Ms. Advisor, you’re telling me that the only fee you receive is the fee I pay you, the advisory fee, maybe the 1%. And beyond that, you’re neutral.”

And the reality is, you are neutral and that is the only fee you receive. Of that transaction charge, you as the RIA do not receive any of that. That is 100% retained by the custodian. That’s one of the ways a custodian generates revenue. To the degree your client sees that, you want to make that very clear, “Mr. or Mrs. Client, this is how a custodial arrangement works. In some instances, there could be these transaction charges and just know Mr. or Mrs. Client, myself as the RIA, receive none of that. That is entirely retained by the custodian to facilitate that trade and to send your confirmation and to custody those assets.”

The reason I say this is because once you explain, it’s very transparent to the client. “Client, I receive none of that. It’s actually in your best interest that you pay it because, again, there’s no conflict. If I go into your account and feel that it’s appropriate to do a rebalance or it’s appropriate to sell one position and buy another position, just know that I as the RIA am not benefiting from that transaction at all. I’m doing it solely because I think it’s in your best interest to make that trade at this time. That transaction charge you see does not impact me at all. That is retained solely by the custodian.”

Again, by default, most custodians set up accounts so that it defaults to the client to pay this. Now, some advisors and RIAs, are sensitive to that or they don’t want the client to see it or to pay it or they don’t want to have that conversation. And so, there generally is the ability to, in turn, instruct the custodian…”Custodian, instead of charging the client, charge that transaction charge to me as the RIA.” That is very doable. The regulations allow that. There’s a number of disclosures that need to come with it though.

There are challenges to that. I’m not indicating that one way is necessarily right and one way is necessarily wrong but keep in mind there is that kind of an inherent conflict of interest. If you elect to do that as an RIA, the challenge with that, and whether or not you would ever maliciously make a decision based on this or not is one thing, as long as there’s the perception, is that something you want to avoid altogether?

What I mean by that is you, the RIA, absorbing these transaction charges. Let’s say you use mutual funds that are not on that NTF list, and there is that transaction charge. All other things equal you decide that you should do a number of trades in client accounts, or it’s a quarterly rebalance. Maybe you rebalance on a quarterly cycle. If you’re absorbing all these transaction charges, every time you decide to make that transaction or make that trade, that’s a big expense, possibly thousands of dollars – depends on the number of accounts involved – that gets pushed back to you as an RIA.

It creates, at a minimum, a perception of a conflict of interest that, arguably could you say…”Well, maybe we should rebalance. But maybe the accounts actually aren’t that far out of our target ranges. And if I rebalanced, it’s going to cost me X thousands of dollars. So maybe we’re okay just leaving them as they are for another quarter.” I’m of the opinion, you generally want to try to avoid that conflict whether from your own personal way of having to run the accounts but more so for the clients.

You can cleanly say (if you have the client pay the transaction charges), “Client, it doesn’t make any difference to me whether we do one trade or 100 trades. I’m paid the 1% fee (or whatever the fee is) from you. And I receive none of these transaction charges.”

That’s my personal opinion. I would tell you though there are a number of advisors that do it and it’s perfectly fine. Sometimes the justification is….“98% of the trades I do are at zero anyways because they’re equities or ETFs or they are on that NTF list. There’s only a small number of mutual fund trades that occur that are not on this NTF list. It’s just easier for me to absorb those than having to have that conversation with clients. It’s such a de minimis amount of money that I’m comfortable that no one would think I’m conflicted about whether I want to absorb that amount each time it occurs.”

Pros and cons to each. Just know it is possible to do both. And generally, the default is to go to the client. Or the RIA has the ability to absorb it.

One way to try to further avoid that, to the degree you can and desire to, is to look at those NTF lists. I’ve talked to many RIAs that say….”I do use mutual funds. I make models. I generally aim to choose which mutual funds to use from that NTF list.” And, again, it’s the bulk of the mutual funds that are out there available for you to use. If you build models that are entirely comprised of mutual funds that are on this NTF mutual fund list, then this whole issue is a moot point. There is no transaction charge. You don’t even need to worry about asset-based pricing. You don’t need to worry about absorbing the fees. And so, that is another strategy as well. It’s to say….”I’m going to purposely try to fall within these NTF lists.”

The idea of asset-based pricing is something to consider as well because, in theory, it eliminates all of this conversation, albeit it does then introduce that perhaps 3bps fee. And, again, the question is “Well, who would absorb that? Would that be the client or the RIA?” That perhaps has a little less conflicts because if it is a (for example) flat three basis points whether you trade one time or 100 times, then there’s no conflict of….”Should I do this rebalance this month or not”…if it’s always going to be the same, perhaps three basis points.

To wrap up on that, the point is there’s pros and cons to all of this. It’s not to say that one for sure is the better path than another. It’s mostly a dialogue with the client helping them understand….”Okay, here’s how the RIA and custodial world operates. Here’s how I’m paid as the RIA. Here’s how a custodian generates revenue to cover the cost of holding your assets, clearing trades, sending you confirmations.” Generally, I’ve found RIAs have no problem with this. Once they explain it to the clients, the clients understand how it works, and it’s not a big deal at all.

I think it is important, that’s why I wanted to make this video, that you do understand when transaction charges still, to this day, exist. Like I said, a lot of it has gone away but they still exist in some capacity. And then the question is, who actually pays for it and what are those options?

With that, I’m Brad Wales with Transition To RIA. What I do is help advisors just like you understand everything there is to know about why and how to transition to the RIA model.

Today’s topic is a perfect example about how does this work in the RIA model? If I were to move to the RIA model how does trading work? How does transaction fees work? I hope you found this to be helpful. This is the exact sort of thing I do with advisors.

If you jump over to, if you’re not already there, to TransitionToRIA.com you can see plenty more videos just like this one. I have some whitepapers as well. The easiest thing is right there at the top of the website is a contact link. You can jump on there, instantly and quickly schedule an exact time and date to discuss with me everything you want to know about the RIA model, and of importance, how it would apply to your specific arrangement. What kind of firm are you at? What kind of affiliation model are you at? What kind of clients do you have? What do you want to do with your practice? And then, how would that look as an RIA model? I’m glad to have that conversation with you. I’ll walk you through as many details as you want to learn about.

I hope you found value in today’s video, and I’ll see you on the next one.

Want To Learn More?

Schedule a Discovery call and lets begin a conversation.

Share this post

Read my free whitepaper!

Get instant access to my free whitepaper on "11 Ways The Economics Of The RIA Model Are Superior To Other Advisor Affiliation Options".
FREE WHITEPAPER:  “Steps To Take Now If You Anticipate Transitioning Your Practice To The RIA Model Anytime Within The Next 10 Years.”