The Difference Between a “Fee-Based” and “Fee-Only” Financial Adviser

Investing
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By Gary E.D. Alt, AIF®, CFP®

Learn more about Gary on NerdWallet’s Ask an Advisor

Fee-only financial advisors

More investors are choosing to work with a “fee-only” financial advisor, and for good reason.  The advisor has no conflicts of interest over the investments they recommend to you.  They usually charge a fee that’s calculated on the total value of your account, regardless of the investments.  There’s no financial incentive for her to recommend one investment over another – she gets paid the same amount regardless of the investments in your account.  Her goal is the same as yours – growing the account value over time.

Intentional Confusion

But investors aren’t the only ones waking up to this trend – so are the traditional retail brokers.  In fact, they’ve created intentional confusion by inventing the term “fee-based.”  Fee-based means the advisor charges both a fee and commissions.  But rather than mentioning commissions, they hide it by labeling their practice as fee-based to make it sound more like fee-only.  Fee-based is not the same as fee-only.

Kevin Keller, chief executive of the Certified Financial Planner Board of Standards, was quoted in a November 10th Wall Street Journal article, saying “we believe that ‘commission and fee’ is a more accurate and understandable term than ‘fee-based.’”

So why hide the truth?

The Ugly Truth of Commissions

When a consumer walks into a big-box brokerage firm, they expect to receive impartial and objective investment advice based on their personal needs and concerns.  But different investment products pay different commission rates, even for identical or similar products.  For example, brokerage firms usually pay a higher commission if the rep recommends one of their own in-house mutual funds.  Reps can get fired if they don’t sell the “home brand” according to a March 2nd New York Times article.

The selling pressure from management creates a conflict of interest for the advisor.  Should he bow to management to sell the house brand of products and earn a higher commission, or should he recommend a fund from another company that isn’t as lucrative, even if it’s a superior investment?  When you see an investment in your portfolio you’re left wondering, “Is this investment the best available for me, or is it more lucrative for my advisor?”

The first way to eliminate the conflict of interest is to get rid of commissions.

Even Better for You – a Fiduciary

A fee-only advisor can go even further to be on your side, working under a “fiduciary” standard of care.  SEC Commissioner Elisse Walter called the fiduciary standard the “gold standard” at a conference last May.

As a fiduciary, an advisor is legally obligated to put his clients’ needs first.  This requires more than simply following a long list of rules, but requires him to continually be aware of potential conflicts as they arise.  The fiduciary is always asking himself, “could my advice create a conflict of interest with my client?” It’s not a one-time question, it’s a continuous effort.

When I’ve explained the fiduciary concept to people as “putting clients’ needs first,” the most common response I get is, “don’t all advisors put their clients’ needs first?”  It seems like an obvious expectation.  But while many advisors say they put clients first, most will not agree to a fiduciary promise in writing, especially at a large brokerage firm.

Commissioned brokers and fee-based advisors can work under a lower standard called the suitability standard.  They’re only required to choose something that’s good for the client based on their age, financial situation etc.  But the suitability standard allows conflicts to exist, even if the disclosure is buried deep in an 84-page prospectus, which most people don’t have the patience to read.

Choosing a fee-only financial adviser

Now that you understand the importance of a fee-only adviser, how do you find one?  The National Association of Personal Financial Advisers (NAPFA) only accepts fee-only advisers into its ranks, and their website has an adviser locatorFi360 is the accrediting organization for Accredited Investment Fiduciaries, and they also have an adviser locator.  The Financial Planning Association accepts all advisers, including those who accept commissions-only, so it may be more difficult to find the right adviser through this organization.