Are you a 'reverse churning' victim?

You've probably heard about the fee-based financial advisory model—and "broker" being relegated to dirty-word status—but do you know about reverse churn? You should, before you opt for the fee-based model simply because it's becoming commonplace.

The idea behind fee-based accounts is that you are paying an ongoing fee in lieu of brokerage commissions as compensation to your financial advisor. It's typically based on a percentage of the value of your account and recalculated periodically (usually quarterly) to account for changes in the value of assets.

Financial Advisor
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Fee-based has become more popular for a good reason: If your account value rises, the fee would rise, and vice versa if your account value falls. The model puts you and your advisor on the same team. Better yet, this form of compensation discourages advisors from churning accounts to generate extra commissions and from investing assets in potentially unsuitable high-commission financial products, such as non-traded real estate investment trusts and other illiquid private placements.

But hold on a second.

While a fee-based account is perceived as some sort of advisory promised land of fairness, it isn't for everyone.

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Sometimes an old-fashioned brokerage account could make more sense for you. If you have an account that is inactive or just sitting on investments with very little chance of being bought or sold, then a fee-based account could actually be harmful to you.

You would be in the detrimental position of paying an extra expense for nothing, making your account an unnecessarily expensive financial product. So while "broker" has become a dirty word these days, the reality is that, depending on the circumstances, a brokerage relationship could be a better choice for you.

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True, with a fee-based account you are not only paying your advisor to manage your account in your best interests, you are also paying him or her to not recommend anything just for the commission. But with a fee-based account, the financial advisor is supposed to provide ongoing advice and service, in addition to buying and selling securities when he or she feels it is necessary.

When assets are placed into a fee-based account just for the sake of the advisor collecting the fee, with little or no ongoing advice, service and/or trading, it's called reverse churning.

In fact, if you do an Internet search of that term, you'll see article after article about how serious the securities industry's main regulators—the Securities and Exchange Commission and the Financial Industry Regulatory Authority—are taking this.

In deciding which type of account is better for you—fee-based, brokerage or possibly both—you and your financial professional will need to determine the level of ongoing service advice and investment management that you desire in order to make the most appropriate choice.