Fee-only vs Fee-based Advisors
Prospects often tell us that they want a "fee-based" advisor. However, when they start to describe this advisor, they are actually describing a "fee-only" advisor!
Having a clear understanding of this difference is essential. Not only will you have a better understanding of the industry, but you will be better armed to ask the right questions should a potential conflict arise.
OUR TAKE: A fee-only financial planner sounds strikingly similar to a fee-based financial planner - but there is a huge difference in how they get paid, and thus the accompanying recommendations and outcomes.
A fee-only financial planner is compensated only by the fees he or she charges directly to clients and not by commissions earned from a sale of a financial product. An advisor compensated only by fees is called fee-only. Fee-only does not mean flat-fee though it is one of the potential options. The fee-only planner charges a fee that is one of the following:
- A flat-fee or project-based fee
- An hourly fee
- A percentage of assets under management (AUM)
A fee-based also known as a “fee and commission” advisor is generally compensated by both fees for advice and commissions (received from the investment company). Most fee-based advisors hold licenses that allow them to sell investment products or insurance for a commission.
OUR TAKE: If you don't know whether your advisor is fee-only or fee-based, simply ask. If the answer seems confusing, you can bet the answer is fee-based.
Too often, the public is unaware of these subtle differences in title. In my opinion, there are 3 major conflicts with the fee-based model:
As stated earlier, a fee-only financial planner is compensated only by the fees he or she charges directly to clients. Fee-based advisors generally do not have a “duty to disclose” their method of compensation and this can confuse clients who may not understand that they are also working for commissions. Simply put, it causes a lack of transparency.
There is an inherent bias with commission-based advisors. Basically, anytime someone is paid on a commission basis, there is going to be a natural motivation to sell products that pay out the highest commissions.
2. Conflicts of Interest
One of the major benefits of working with a fee-only advisor is that they have no inherent conflicts of interest and they generally provide more comprehensive advice. A fee-based advisor may carry an incentive to recommend a product with a higher payout to the advisor (which typically corresponds to higher cost for the client).
The National Association of Personal Financial Advisors (you can search for advisors here) is the leading professional organization for fee-only advisors. NAPFA is distinguished both by the competence of its advisors and their method of compensation.
Another great resource to learn more is The Fee Only Network (you can search for advisors here, too). It goes without saying, but a requirement to join either organization is to be fee-only.
3. Fiduciary Standard
Typically, fee-only advisors conduct their business under a “fiduciary duty,” which means by law, they must have their clients’ best interest at heart. Many fee-only advisors carry professional designations that hold them to strict codes of professional and ethical conduct.
Fiduciaries must make sure their recommendations are based on accurate and complete information. That means they are required to thoroughly analyze your accounts, goals and circumstances before recommendations are made. Fiduciaries must then monitor their recommendation to make sure that it remains appropriate for their client on an ongoing basis.
A fiduciary advisor will help you minimize fees, avoid conflicts of interest and put you at the center of any financial advice. If your current financial advisor doesn’t seem to model these behaviors, consider finding one who does!
OUR TAKE: At the end of the day, you want to judge the advisor as a person in addition to his/her business model. If you have been working with a fee-based advisor that has served you well for many years, there may be no reason to change. However, if you find yourself needing a new advisor, we would strongly recommend starting your search with fee-only advisors.