The financial services industry has no shortage of jargon and acronyms that can confuse investors as they try to diligently research what type of financial advisor may be right for their situation. Understanding the difference between a "fee-only" financial advisor and a fee-based advisor paid by commissions is crucial for all investors.
Fee-only Financial Advisors
Fee-only advisors are free from the potential conflicts of interest that other advisors may have when part of their compensation is based on commissions or sales. The term "fee-only" means that these advisors are only compensated by their clients (typically as a percentage of their portfolio); they do not sell financial products (like insurance or stocks), receive commissions, or other revenues from 3rd parties.
Although often confused with an hourly or project-based compensation arrangement, fee-only financial advisors typically charge a percentage of assets under management and/or a flat retainer fee. When an advisor is compensated only as a percentage of the assets that they manage on your behalf, they're with you when the market goes up - and when it goes down.
Investors are typically more comfortable with the fee-only arrangement because it sets the stage for a trusting relationship to develop. Rather than feeling like you're being "sold" something, fee-only advisors can be an objective source of financial advice.
Darrow Wealth Management is a fee-only financial advisory firm.
Fee-based Financial Advisors
Fee-based advisors can be compensated by client fees and commissions for selling financial products (like insurance or annuities) and securities (e.g. stocks, mutual funds) to their clients.
The commissions on these products can be substantial which can create concerns about conflicts of interest.
Who's Acting in Your Best Interest?
A fiduciary standard requires an advisor to act at all times in the client's best interest. Registered investment advisors are held to a fiduciary standard, which means they are obligated to put their clients' interests ahead of their own at all times in the relationship. This is the highest standard of care under the law.
Although many fee-only financial advisors are registered investment advisors (and fiduciaries), it's possible for a firm to be one and not the other.
Recent legislation (the now-defunct Department of Labor's Fiduciary Rule and Regulation Best Interest (Reg BI) which goes into effect in June 2020) has been aimed at raising the standards for broker-dealers and the "advisors" that work for them. At a high level, under previous rules, brokers operated under a suitability standard, which meant recommendations need only be suitable for the investor, but not necessarily in their best interest. In contrast to fiduciary duty, brokers were obligated to act in the best interest of their employer, not their client. Under Reg BI, brokers will be required to act in the client's best interest, but at the time a recommendation is made; it is not an ongoing duty of care.
Darrow Wealth Management is a registered investment advisor, so we're always required to act in client's best interest.
Independent Advisory Firm
A truly independent financial advisor has no affiliations with a large brokerage firm. Why is that important? As an independent fee-only advisor, we often make referrals to other professionals when clients are in need of insurance or other products. The professionals in our referral network are not affiliated with us and we have no compensation agreement; the referral is made based on client need alone.
Independence is also critical in asset management. Independent firms will typically cast a wide net and review a global spectrum of investment options before making any selections. Firms with an affiliation to a broker-dealer and other fee-based advisors will often be loyal to a fund family due to compensation agreements and commissions.
Today, many financial advisory and wealth management firms operate as a subsidiary of another larger, parent firm. For example, large brokerage firms such as LPL Financial and Merrill Lynch often have affiliations and partnerships with smaller firms. The smaller firms can still call themselves "independent" or a registered investment advisor, but they will still need to disclose the relationship, which is why it is always important to read the fine print provided. In this type of relationship, a client referral would likely stay within the network.
Many investors will choose a fee-only advisor once they understand the difference in compensation arrangements. Before deciding on a financial advisor, do your homework and ensure you are comfortable with the firm. After all, if you don't trust the recommendations provided by your advisor, why are you paying for them?
Darrow Wealth Management is proud to be:
A fiduciary always acting in your best interest
Second-generation family business
Predominantly women-led firm