Churning: Sometimes constant contact from your advisor is a BAD thing…

Most investors who are looking for the services of a financial advisor would expect a certain level of constant communication: Quarterly portfolio or market reviews, annual face to face meetings to update financial plans and the odd unscheduled phone call if market conditions warrant it.

businessman_on_phone1.jpgBut there are some advisors out there who maybe call their clients too often and who are constantly suggesting changes to their clients’ portfolios.  If that is happening to you, you need to be looking out to see if your advisor may be "churning" your account.

Churning is defined as the excessive trading in a client’s account in order to increase the commissions generated to the advisor.  Churning is mostly associated with stock-brokers who use a transactional fee model – which means they generate a commission when you buy OR sell a stock.  Financial advisors who only use mutual funds (also known as Mutual Fund Sales Representatives) can also be guilty of churning if they are constantly switching you in and out of different mutual funds which are sold using front-end charges OR back-end charges since they earn a commission on each of those transcations.

But then a question needs to be asked: If an advisor’s frequent recommendations result in superior performance for the client, is this churning?  Well if the performance is there to validate the recommendations then most investors would say no. If the fruits of your labour (frequent trading) yield no real advantage to you, then your advisor may indeed be churning  your account! This generally cannot be determined over short periods of time as you may need time for investment strategies to play out. Internal compliance departments monitor the actions of their brokers over time and churning is becoming less prominent over time – but it still does exist.

If you use an advisor who is licensed to sell individual stocks and bonds instead of just mutual funds, you can look into "fee-based" accounts as an alternative option.  These accounts do not charge a commission based on each transaction, but rather charge an annual fee which is based on the size of your portfolio.  For example, if you have a $100,000 account perhaps you have negotiated a set fee of 1.50% to manage your account which does not vary if you make 2 transactions per year or 20.

…and certainly, if you are comfortable managing your own investments then you would be better off opening an online discount brokerage account.  I’ve never heard of someone churning their own account! :)

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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