What is the Difference Between “Fee-Only” and “Fee-Based?”
Consumers are frequently confused between the terms Fee-Only and Fee-Based assuming they mean the same thing. However, these terms refer to how your advisor is compensated and they have vastly different meanings. Whether your advisor is “Fee-Only” or “Fee-Based” will have a huge impact on the type of advice you are provided and the types of investment products which are recommended to you.
Fee-Only means the only source of compensation your advisor receives is from fees paid directly to the advisor from clients. This could be in the form of an hourly fee, a retainer fee or a percentage of the assets under management. Regardless of the type of fee, the point is that the client pays only a fee and no other type of compensation is charged. No commissions are received. No financial products are sold. No commissioned annuities are recommended. Advice is totally independent of the financial products recommended.
Fee-Based is a term the brokerage community developed to counteract the success of the Fee-Only classification. The terms certainly sound similar and consumers are confused, so their strategy seems to be working. Where Fee-Based can be misleading is that not only does an advisor receive fees under a Fee-Based compensation system, but they can also accept commissions from financial products recommended, or annuities and insurance sold. This system creates the potential for a huge conflict of interest. If an advisor has the opportunity to recommend a particular financial product that pays him/her a commission versus a financial product that does not pay a commission, which one do you think they will recommend?
So when deciding which advisor you would like to hire, we would suggest that you ask how the advisor is compensated, request that they disclose their compensation in writing and look for someone who is paid as a “Fee-Only” advisor to eliminate as many conflicts of interest as possible.
What is a Fiduciary and Why Does it Matter?
Do you know one thing in common between a Doctor, a Lawyer and a CPA? They are all fiduciaries. This means they practice under an oath to provide you with advice or a level of care that is solely in your best interest and free from conflicts of interest.
Unfortunately, not all financial advisors operate under this same oath of conduct. As a consumer, it is important to know that you have a choice when hiring a financial advisor and that there are a select group financial advisors that do operate under a fiduciary capacity much like your doctor, lawyer or CPA.
Your typical stockbroker, insurance broker, annuity sales person, or investment consultant at a bank works under a lesser legal standard called suitability laws. This means they can recommend investment products that are suitable for your situation, but not necessarily the absolute best option for your financial situation. Under their lower legal standards they are able to recommend financial products that are in their best interest and not your best interest. They do not have to disclose their compensation, they do not have to disclose their commissions from financial product sales and they do not have to disclose any conflicts of interest.
In comparison, a Registered Investment Advisor, is held to a fiduciary standard, which is considered the highest standard of care available for an investor. Investment Advisors operating as fiduciaries provide all recommendations in writing, all fees or compensation are disclosed and any recommendation provided to you must be absolutely in your best interest.
So if you want unbiased advice, free from conflicts of interest and you want an advisor that will invest your money as though it is their money, than make sure you are working with a Registered Investment Advisor that holds themselves out as a fiduciary and is willing to put that in writing.
How do I choose a financial advisor?
We believe that when choosing a financial advisor you should consider the following attributes:
- Choose a financial advisor that is also a Certified Financial Planner (CFP®). This is considered the premier designation in the financial industry. A financial planner with this designation has passed a 10 hour board certified exam, has 3 plus years of financial planning experience and has an undergraduate degree. The curriculum for a Certified Financial Planner is based on comprehensive financial planning including many disciplines such as: investment planning, retirement planning, tax planning, insurance planning, estate planning and college planning.
- Seek a Registered Financial Advisor that operates under a Fiduciary Standard vs. the brokerage industry’s suitability laws. A Fiduciary Standard is the highest legal standard of care available in the industry. See our article regarding “What is a Fiduciary and Why Does it Matter” for more information.
- You should seek a financial planner that is compensated in a fee-only manner vs. one who sells financial products, insurance or annuities for commissions. See our article titled “What is the difference between Fee-Only versus Fee-Based?”, for more information on financial advisor compensation systems.
- Choose someone experienced with clients similar to your type of financial situation. Ask the advisor what their typical client is like, profession, total assets, life situation, advice needed, etc…
- A financial advisor should be independent and not affiliated with any particular company or financial products. An independent financial planner has the ability to recommend what is in your best interest, not that which provides them with the highest commission.
- Keep interviewing advisors until you find one that you feel you can trust. Hiring a financial advisor is a big decision and your financial future is at stake. Your relationship with your advisor should be based on trust and comfort.
- Ask for a copy of your financial planner’s code of ethics to ensure their interests are the same as yours.
- Beware of any promises made regarding performance or statements made regarding the ability to greatly outperform markets.
- Ask your advisor if they are willing to put their fee structure, recommendations and any disclosures in writing. If not, that should raise a concern.