As if sensible investing isn’t challenging enough, some of the related terminology can add even more confusion … like fee-only advisor vs. fee-based advisor.
At a glance, you might assume these are one and the same in your search for a dependable financial advisor. Unfortunately, fee-only and fee-based advisors are not interchangeable. What if you pick the wrong relationship? You could believe you’re entering into one sort of compensation model, when you’re actually entering into another.
What difference does that make? Let’s explain.
Advisors typically earn their keep in one of three ways: fee-only, commissions, or fee-based. Why is it important to understand how your advisor is being compensated – and by whom? It’s one important way to determine whether they will be able to live up to what investors typically want (and, frankly, deserve) from their financial advisor:
“The confusion is in the marketplace because everybody claims to be a trusted advisor when some are really only salespeople. There’s no confusion in the minds of investors as to what they want. They’re very clear. They want somebody they trust who makes recommendations that put their interest first and don’t allow the advisor to profit financially at their expense.” —Phyllis Borzi, DOL Assistant Secretary, 2009–2017
Finley Wealth Advisors is proud to be an independent fee-only advisor. For starters, we like it because it’s easy to explain: Our sole source of compensation is a transparent fee each client pays us for the personalized, fiduciary advice we offer them. Period. We do not accept any other kinds of compensation from anyone else. No commissions or sales incentives. No kickbacks or year-end bonuses. Not even a set of steak knives for recommending one product over another.
When you’re working with a fee-only advisor who has eliminated all other sources of compensation, you know exactly to whom they are beholden: You. From our perspective, being in a fee-only relationship with our clients adds a welcome level of clarity for them and us. It leaves us free to focus on getting to know and understand each client’s best interests. It removes any external temptations to cloud our objectivity.
At the other end of the spectrum, some financial intermediaries are essentially a sales force for their brokerage firm, bank, or insurance agency. They earn their compensation in “eat what you kill” commissions from their parent firm, and/or the product providers whose wares they sell.
Such an intermediary also may offer bits of financial and investment advice that are generally supposed to be in your best interest. The advice may seem “free,” since you are not paying a direct fee for it. But such a climate is rife with external incentives that can compete head-on with your own. Even financial regulators typically consider this form of advice secondary to what is supposed to be a broker, banker, or insurance agent’s transactional duties.
“It is difficult to systematically beat the market. But it is not difficult to systematically throw money down a rat hole by generating commissions.” — Economist Michael Jensen
Last but not least, we arrive at “fee-based.” Like a fee-only advisor, a fee-based advisor charges you a fee for the advice they offer. But a fee-based advisor can also accept commissions and similar sources of compensation. These added incentives typically come from third-party providers whose products they are recommending to you.
If anything, we’re more concerned about fee-based relationships than we are about straight-commission types. Not only do the same conflicts of interest arise, it’s often far less clear just where a fee-based advisor’s loyalty lies.
You can research the details of their arrangements by reading their financial regulatory disclosures. But, frankly, good luck fully understanding all of the particulars tucked away in the fine print.
“Will investors already reeling from information overload peruse yet another regulatory document? If you believe that, you should hear my pet salamander play the harmonica.” — Jason Zweig, The Wall Street Journal
Fortunately, we can help you cut through some of the confusion. We still encourage you to read through a would-be advisor’s regulatory report; it’s there for a reason. But now, whenever any financial intermediary wants to offer you “free” investment advice, you have a potent question to lead with.
Should you take the advice? Start by asking this simple question, with its simple, “yes” or “no” answer:
Are you a fee-only advisor?
Douglas Finley, MS, CFP, AEP, CDFA founded Finley Wealth Advisors in February of 2006, as a Fiduciary Fee-Only Registered Investment Advisor, with the goal of creating a firm that eliminated the conflicts of interest inherent in the financial planner – advisor/client relationship. The firm specializes in wealth management for the middle-class millionaire.
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