By Laurel Hardy
Learn more about Laurel on NerdWallet’s Ask an Advisor
If I weren’t a fee-only financial advisor, I would have some serious questions about what I should be looking for in an advisor. Do you know what it means when someone says he or she is a fee-based advisor?
I left my position as a fully licensed financial advisor at a well-known wire-house investment firm and bank, where I was paid on commission and offered fee-based services, to open my own fee-only investment and planning firm. For those wondering what the difference is between commissions, fee based, and fee-only service, here’s are my observations.
- Advisor is a fiduciary required by law to act in your best interest.
- Registers as an investment advisor; is not a securities broker employed by a broker/dealer firm.
- Advisor compensation is fully disclosed and paid directly by the client.
- There is no additional compensation when a product is purchased.
- Your advisor can discuss how much you’re willing to pay for an investment product and tailor investment recommendations to your specifications instead of choosing from a suite of similarly priced (and usually more expensive) offerings approved by a broker/dealer firm.
- Recommendations need only meet a standard of suitability, not a fiduciary standard.
- Compensation is tied directly to the purchase of a recommended product.
- Advice can be limited to product recommendations.
- Product recommendations are limited to an “approved” list by the broker/dealer firm.
- Proprietary products may have higher fees, which are not required to be fully and clearly disclosed.
- Clients often believe there are no fees being charged for the advice, when in fact the fees are simply hidden.
- Management pressures sales force to push certain products.
- Some advisors paid by commission are very honest, reputable, and intelligent individuals that are quite worthy of respect. They are very good at what they do, and very knowledgeable. The ones that are not in that category, however, tend to hide amidst the really good ones, making differentiating who’s who difficult for the average consumer.
- Refers to a fee structure in which commissions in the form of fees are payable to an advisor based on ongoing account management instead of trading activity.
- The term “fee-based” often refers to “managed accounts,” but they are not interchangeable.
Why have these different forms of compensation evolved? Because it’s what clients want. Some clients prefer to have their advisor compensated based on commissions because they feel it encourages advisors to make better investment decisions—the idea being that the larger the account balance, the larger the commission payment, encouraging their advisor to grow the account.
The other side of the argument is that compensation by commission may encourage advisors to trade too often. There are also concerns that advisors paid on commission will push certain products or investments that are likely to pay them more.
I believe there are selfish advisors and selfless advisors who earn compensation in both ways. Every advisor wants their clients’ accounts to grow! We wouldn’t be in this business if we didn’t enjoy working to make that happen.
We really don’t need commissions to encourage us to do well if we take pride in our work. Fee-only advisors are the preference of some, commission advisors are preferred by others; but the important issue when working with an advisor is to choose one that you trust.
The great advisors work to make your financial plan and investments perform best for you.