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; they do not sell financial products (like insurance or stocks) or receive commissions.
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.
Fee-based Financial Advisors
Fee-based advisors are compensated by both client fees as well as commissions for selling financial products and securities to their clients. Unlike fee-only advisors, who receive no financial incentive for trading on a client account, fee-based advisors are often compensated with commissions from the securities they sell.
Unlike advisors with a fiduciary duty, fee-based advisors are held to the lesser "suitability" standard. This means that recommendations need only be "suitable" for a client's financial situation and not necessarily the "best" option for them.
Fee-based advisors may also sell financial products in addition to securities, such as insurance and annuities. The commissions on these products can be quite large, and investors aren't always as confident that the recommendations are being made in their best interest.
Although many fee-only financial advisors are also held to a fiduciary duty, this is not always the case. Registered investment advisors are held to a fiduciary standard, which means they are obligated to put their clients' interests ahead of their own. A fiduciary duty is in contrast to the suitability standard, which fee-based and commission only advisors are held to.
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?
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