Financial advisors today have several different platforms to choose from when it comes to managing their businesses. Some charge only commissions, while others charge a combination of fees and commissions for their services. But many advisors today are now opting to jettison their broker-dealers altogether and run a fee-only practice. Some firms also still provide insurance and annuities on a commission basis, but others have eschewed even this approach and adopted a holistic fee-only structure for all of the products and services that they offer.
Fees Versus Commissions
Fee-based planning can provide both financial planners and clients with several key advantages over commission-based planning. One of the most obvious benefits for clients is that they know exactly what they are paying and receiving in return for their money. Most fee-based advisors charge either an hourly fee or a flat fee for services rendered. There is little or no fine print that they must try to find and read in tedious prospectuses or other sales materials that may reveal substantial additional fees or penalties that the advisor might neglect to mention at the time of purchase.
Many registered investment advisors (RIAs) also structure their fees as a percentage of assets under management (AUM), which directly aligns their financial interests with the client, as their percentage will increase proportionately as their clients’ funds grow over time. Advisors who work on commission are often faced with the temptation to excessively trade their clients’ accounts in order to generate adequate revenue. And because RIAs will typically always get paid for providing what they offer regardless of their fee structure, they are also more inclined to provide additional services for clients such as comprehensive financial planning and Social Security analysis.
Many commission-based planners have no inclination to offer this kind of non-transactional service because they cannot directly generate any revenue for them. Clients can also rest easier knowing that RIAs are held to a strict fiduciary standard that requires them to unconditionally place their clients’ interests ahead of their own, regardless of all other factors. Even RIAs that also offer insurance and annuities on a commission basis are required to adhere to this high standard when they use these products. Planners who are paid solely on commission must only meet a much lower suitability standard, which merely examines the suitability of a particular product or investment for a customer on an individual transaction basis. Furthermore, the media has enthusiastically promoted fee-only advisors to the public for the past several years, touting them as a safe haven for uneducated consumers who do not want to fall prey to unscrupulous predatorial salespersons.
A fee-based structure can also often provide clients with an additional tax advantage, as anything that they pay out of pocket can be listed as a miscellaneous investment expense on the Schedule A for those who are able to itemize. Commissions are used to reduce the cost basis of capital gains but cannot be listed separately on a 1040 form. It should be noted that there may be times when investors will actually realize greater savings from commission costs than fees paid out of pocket, depending upon the type of account that is used, the number of transactions performed, the amount of gain realized and the investor’s tax bracket.
RIAs also often have it easier when it comes to staying in compliance with regulators. Compliance departments at broker-dealers are required by the Financial Industry Regulatory Authority (FINRA) to monitor those registered representatives with pristine records every bit as closely as those who have racked up an impressive disciplinary history from a myriad of violations that they have committed. But this type of renegade behavior is much more difficult to get away with under the fiduciary statutes, and those who attempt to do so can quickly get their RIA license revoked. RIAs can also have a much easier time getting sales and marketing materials approved and often enjoy much greater freedom in what they are allowed to present in them. The RIA model also often comes with greater bureaucratic simplicity, which allows planners to spend more time growing their businesses and servicing their clients.
As those in the Millennial generation have started to finish their educations and look for jobs, it is becoming apparent that they desire a different type of financial service from their planners and are much more open to a fee-based structure than their parents. Older investors who have always paid commissions may be comfortable with that arrangement, but there may be a substantial reduction in this traditional form of business in the coming years as the younger generation begins to crowd out its elders in the modern workforce.
Advisory firms that charge only fees (even if they also offer insurance and annuities) are logistically much easier to both buy and sell than those that are attached to a broker-dealer. Moving client accounts and rebranding can happen with RIA firms much more quickly and with far less legal and corporate wrangling than when a broker-dealer is involved. This advantage, in turn, makes RIA firms more attractive to potential buyers, who may be willing to pay a much higher price for them.
Although they will not have a broker-dealer to turn to for help in running their businesses, fee-based advisors don’t have to go it alone. The National Association of Personal Financial Advisors (NAPFA) was founded in 1983 to provide professional support for the fee-only crowd. This organization requires its members to adhere to a specific code of ethics and take an annual fiduciary oath that reflects their commitment to running a practice that discloses conflicts of interest, provides suitable written disclosures and, of course, employs a compensation structure based solely on fees.
NAPFA also provides its members with networking and marketing support, opportunities for continuing education and professional development and annual conferences where members can exchange ideas and learn about new products and services and industry innovations. Clients who are seeking a pure fee-based approach to their planning can also find a member planner in their area on the organization's website.
The Bottom Line
Although commission-based selling of financial products is not going to disappear anytime soon, fee-based advisors are enlarging their segment of the financial marketplace and continue to build steam in the race for new customers. Advisors looking to find out more about the advantages of becoming an RIA and charging only fees to clients should visit NAPFA’s website at www.napfa.org.