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Why Edward Jones' Quarterly Results Are a Bad Sign for Investors

This post was updated September 15, 2011.
Ken Rosenbaum, one of my colleagues at Buckingham Asset Management, had an interesting take on why Edward Jones' excellent second quarter financial results might not be good for the firm's clients. I wanted to share his thoughts with you. (Of course, to be fair, we should also point out that both Edward Jones and my firm provide investment advice.)

The St. Louis Business Journal noted that Edward Jones saw profits jump 19 percent in the second quarter. For comparison's sake, Stifel Nicolaus saw a double-digit decline in brokerage revenue in the second quarter of 2011 compared with the previous year, while Wells Fargo's Wealth, Brokerage and Retirement business segment saw its net income rise 23.3 percent. Edward Jones' performance sounds great ... if you're one of the 350 general partners. However, it might not be so great if you're one of the firm's clients. Why? Well, let's take a closer look.

The article points out that Edward Jones credits its increase in revenue to two sources:

  • Higher volume of customer transactions
  • Increased asset values
It also notes that Edward Jones derives revenue primarily from two sources:
  • Trade revenue, consisting of buy and sell transactions from its customers
  • Net fee revenue, consisting of asset fees, account and activity fees, and net interest income
Each of these sources of revenue should be of concern to the firm's clients.

The obvious one is the revenue from trading, which screams conflict of interest between the firm and its clients. The firm makes money by having its advisors advise clients to buy and sell securities. The more trading, the more revenue for the firm and the advisor. (My firm uses a competing model. We charge clients a fee based on percentage of assets.)

However, study after study concludes that trading and investment performance are negatively correlated, meaning that the more an investor trades, the worse his investment performance is likely to be. (By the way, I referenced a male in my example on purpose. The study "Boys Will Be Boys" found that male investors traded 45 percent more than female investors. Turnover reduced net returns by 2.65 percent per year for men, but only 1.72 percent per year for women.)

It reminds me of a dark joke I used to hear during my days working for a brokerage house. A broker told his client that he should buy stock in IBM. Unfortunately for the client, the stock fell after he bought it, and the advisor told the client to sell the shares. Afterward, the broker relayed the story to his branch manager. The manager said, "So the brokerage house made money from the transactions, you made money from the transactions, and the client lost money?" And they both chuckled and said "Well, two out of three ain't bad."

The net fee revenue should also be a concern. The reasons are:

  • Because Edward Jones doesn't provide a fiduciary standard of care, their advisors can recommend funds that provide the firm with greater revenue, even when a superior choice exists for the client. This is possible because Edward Jones operates under the suitability standard, which doesn't require them to provide advice that is in the client's best interests. One can only wonder why investors would work with an advisor who isn't required to provide advice in their best interests.
  • Account and activity fees, which may have nothing to do with the value of services provided.
  • Net interest income, which can create incentives for the firm's brokers to recommend the use of margin (on which Edward Jones earns a spread) to obtain additional assets on which they can earn commission revenue.
These issues beg the following questions:
  • Whose interest does my firm and/or my advisor place first?
  • Whose bottom line are they focusing on more: mine or theirs?
Photo courtesy of socialwoodlands on Flickr.
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