Fee-Based vs. Fee-Only Financial Advisors
At its simplest, Fee-Only advisors only get compensation directly from their clients. Fee-Based advisors can charge their clients fees, but they can also get a commission on insurance sales and revenue sharing based on investment options chosen.
Imagine you go to the doctor, and the doctor does not charge you (or your insurance) at all. Instead, the doctor is paid by the pharmaceutical company when you purchase a prescription. When this doctor prescribes you a medication, would you trust that this doctor is acting in your best interests?
In reality, there are more practical implications that come from being compensated by entities other than the client. Let’s look at some areas of financial planning that can be affected.
Retirement Planning
Fee-Based advisors can sell annuities and are paid handsomely to do so. A typical commission is 5-10% of the value you put in the annuity. Think about this from the insurance company’s perspective. If they have a product that makes them a lot of money, they will provide incentives for their sales-force to sell this product. That is why the commissions are so high; because annuities are so profitable to the insurance company. Do you think it’s a great deal for you if it’s so profitable to the insurance company?
Fee-Only advisors can help you choose annuities that don’t have commissions or surrender charges if they are a good fit in your plan. That’s the point. Because a Fee-Only advisor doesn’t earn commissions for selling products, they aren’t going to recommend an annuity simply because they get a huge commission.
In fact, many annuity companies have nearly identical products available. A consumer will likely pay more and have surrender charges if they buy a commission based annuity vs. a fee-based annuity.
Insurance Reviews
This whole category is right up there with annuities because the commission compensation structure is so similar. Any time you get advice from a Fee-Based advisor on life insurance, disability insurance or long-term care insurance, you need to find out if they also sell these products for a commission.
Don’t get me wrong, there is a good chance you need all three of these types of insurance at some point depending on your unique circumstances. The problem arises with implementation because an agent can make significantly more money by selling you certain products over others.
The classic example is agents pushing permanent life insurance when someone needs term. This behavior makes sense because commissions are based on premiums paid. Permanent insurance premiums are significantly higher so the agent stands to make significantly more by selling you a permanent policy over a term policy.
Remember Warren Buffet’s quote, “Don’t ask the barber whether you need a haircut.”
A Fee-Only advisor will be able to provide objective advice on these types of policies because he or she doesn’t stand to benefit by recommending certain products over another. Their compensation remains the same regardless of the decision.
Keep the advice and the sales separate.
Debt Strategies
Both Fee-Only and Fee-Based advisors who charge a percentage of assets have a major conflict here, and on any other recommendation that affects the size of the portfolio being managed.
Consider a discussion on whether or not to pay down a mortgage. There is a good chance the discussion involves paying the mortgage down or investing more money (or taking money from investments to apply to the mortgage). Any advisor that charges a percentage of assets managed stands to lose.
Another example is when discussing whether or not it makes sense to roll an old 401k or employer plan to an IRA managed by the advisor.
This is Provision Financial Planning’s primary conflict of interest by far. We seek to mitigate it as much as possible by writing about it like this and reminding the client of this fact when discussing the options.
Investment Management
Fee-Based advisors hold sales licenses in addition to the ability to charge fees. This means that these advisors will have an incentive to recommend or purchase certain funds that pay them a commission, commonly referred to as loads and 12b1 fees. If you are unfortunate enough to have an advisor that charges you a fee and takes these commissions on the same account, run! This is particularly egregious and you should consider filing a formal complaint.
Fee-Only advisors are only compensated by their clients. They will not receive any commissions from investment fund companies for recommending their funds.
Fee-Only advisors simply do not have as many conflicts of interest that other advisors do. This does not make those advisors less capable or less honorable, but it does mean that they will make more money by recommending certain products as a part of their recommendations. Do you want this conflict in your advisory relationship?