In the financial world, advisors and planners are compensated in one of two basic ways: by earning flat fees or by earning commissions. A fee-only financial advisor is paid a set rate for the services they provide rather than getting paid by commission on the products they sell or trade.
Should you be working with a fee-only financial advisor? There are many benefits to someone who is compensated solely by what they charge directly to clients and not from the commissions earned from the sale of financial products or financial transactions. However, there are drawbacks as well. Let's review.
- Many financial advisors are shifting to a fee-only compensation structure, where they receive the same flat fee for their planning services in lieu of traditional commissions or a percentage based on assets under management (AUM).
- The benefits of fee-only include transparency, no hidden charges, and no conflicts of interest to sell a certain product line or company offering.
- The downsides of fee-only advisors can include being more expensive or a limited scope of products and services offered.
- Financial advisors who manage money outright tend to be fee-only.
- Fee-only advisors aren't always completely free of conflicts. If they're compensated by a portion of AUM, they may be biased against you withdrawing funds.
Fee-Only or Commission-Based?
The basic compensation models for financial advisors are:
- Charging an hourly or a flat fee for the planning services they provide. Depending on the engagement, they may provide limited or comprehensive advice. Engagements may be one-time or ongoing.
- Charging a percentage based on assets under management (AUM)—say, 1% of the investment account value. The engagement may or may not include planning and/or other advice, which is usually secondary to money management.
- Earning commissions based on the sale of a product or a financial transaction, such as a stock trade. Advice or planning might be ancillary to the product sale (as with a stockbroker), or they might be a key part of services (as with a financial planner).
- Getting compensated through a combination of flat fees, percentage of AUM, and/or commissions. The exact mix varies by the advisor. Also known as "fee-based," this model allows advisors to offer clients a wider range of services as well as work with them to implement recommendations and monitor progress.
There has been some debate as to how "fee-only" compensation should be defined—mainly, whether or not it should include the second group, those who charge based on AUM. Generally, though, most agree, fee-only refers to payment from fixed, flat, hourly, or percentage-based fees.
Advantages of Using a Fee-Only Advisor
One of the major benefits of selecting a fee-only advisor is the freedom from the inherent conflict of interest that can arise when a significant portion of the advisor’s income comes from selling financial products to you. The concern you should have as a potential client is whether or not the advisor is recommending a certain investment because it enhances their bottom line and if the products recommended are truly in your best interest.
In fact, there are some registered reps and others who earn all or part of their compensation via commission that may be required to favor products offered by their employer—which may or may not be the best investments for your portfolio strategy.
Since fee-only advisors do not sell commission-based products, receive referral fees, or collect other forms of compensation, the potential for conflicts of interest is limited. For this reason, many recommend that you only work with a fee-compensated advisor.
In addition, an advisor is usually a fiduciary when they charge a fee for planning services and/or they are investing money for an advisory account; as a result, they are legally required to always act in the best interest of their clients, and to disclose anything that might smack of impropriety. Registered Investment Advisors (RIAs) and certified financial planners (CFP®s) both swear to act as fiduciaries, for example.
An advisor who only earns commissions—like a stockbroker—is held to a lower standard and does not have to make a "best-interest" recommendation, but rather one that is "suitable" for your needs.
Another benefit of using fee-only financial advisors is the opportunity for them to offer an objective second opinion of your situation. This is especially true if the advisor works with clients on an hourly, as-needed basis or perhaps will do a financial plan or financial review for a fixed project fee. Services here can range from addressing a specific financial question to a review of your investment portfolio or a full-blown financial plan.
Disadvantages of Using a Fee-Only Advisor
All of the above are great reasons to use fee-only advisors, but there are still some potential downsides to the fee-only model.
First, fee-only advisors might be more expensive. For example, let's say through the planning process, a fee-only advisor discovers a need and recommends that a client buys a commission-based product such as disability income insurance. If the fee-only advisor doesn’t sell the product, then the client would need to find and work with an insurance broker, adding additional steps to an already complex process.
Also, the insurance broker receives a commission from the sale of the product, so the client ends up paying both a fee and a commission (albeit to different people).
Some states limit an advisor's ability to charge a fee for the analysis of just insurance products or needs.
Consequently, the fee-only advisor has to either limit the services they offer and/or charge clients a higher fee. For wealthy individuals who are willing and able to pay a substantial retainer, a fee-only advisor could be the right choice. But, for many individuals with limited resources or whose assets are tied up in qualified plans, the out-of-pocket costs for a fee-only advisor could get prohibitive.
Fee-only advisors can be expensive in another sense. Investors with smaller portfolio balances or lower transaction activity may get favorable pricing with commission-based advisors. While fee-only advisors are relatively less expensive for clients with large portfolios, different fee structures impact investors differently.
Fee-only advisors are also in the unique position of holding fiduciary responsibility over your assets, yet they do not get incrementally rewarded for your success. Whether your portfolio doubles in size or gets cut in half, a fixed-fee advisor will likely receive the same fees to manage your portfolio. As there is minimal incentive to the advisor to ensure your investment success, you may find fixed-fee advisors may not always have your best interest at heart as well.
Another issue to consider is that being fee-only does not ensure that the advisor is competent or appropriate for you. While it conjures up the image of an erudite professional, like a lawyer or an accountant, this compensation model doesn't guarantee the advisor has expertise—or that their expertise dovetails with your needs and profile.
For example, a fee-only advisor who specializes in working with teachers and government employees nearing retirement probably would not be the best advisor for a high-earning thirtysomething professional in the private sector.
Fee-Only Financial Advisors
Less chance for conflicts of interest
More transparent pricing structure
More objective advice
Often more expensive/skewed to higher-income clients
More limited in product and service offerings
May not be totally disinterested (if you want to withdraw funds)
How to Find a Fee-Only Advisor
The National Association of Personal Financial Advisors (NAPFA) is one of the largest professional organizations of fee-only financial advisors in the country. It has a find an advisor link on its website. You can search by zip code and then further by area of specialization. Note that NAPFA members run the gamut from solo practitioners to large multi-advisor firms. Additionally, NAPFA members offer a wide range of service options, including hourly as-needed services, ongoing investment and portfolio advice, and almost everything in between.
The Garrett Planning Network is another organization of fee-only financial planners who mostly focus on providing hourly advice. There is a degree of overlap in the membership of the Garrett Planning Network and NAPFA. It also has a "find an advisor" function.
The accounting profession also has a financial planning designation for Certified Public Accountants (CPAs) called Personal Financial Specialists (PFS). Please note that while many holders of the PFS designation are fee-only, they are not required to be. As you contact advisors, you will need to ask these folks how they are compensated.
The Certified Financial Planner Board also has a directory of financial advisors who hold the CFP® designation. Again, being a CFP® does not mean the advisor is fee-only. The CFP® Board recently has revised its compensation classifications to include fee-only, fee-and-commission, and commission. There has been some controversy surrounding its definition of fee-only, so investors using this database need to ask and be diligent in investigating advisors found here to ensure they are fee-only. The CFP® Board hosts a 'Find a Financial Planner' tool on their website.
What Does a Fee-Only Financial Advisor Cost?
A fee-only financial advisor's costs can range greatly, depending on their expertise and years of experience, their region, and the services they offer. A flat fee of $1,500 to $3,000 is typical for the original creation of a comprehensive financial plan. Timed or retainer rates can run between $150 to $400 an hour and between $1,000 to $7,500 annually. Those taking a percentage of assets they manage charge on a sliding scale, generally between 1%-2% annually.
What Does a Commission-Based Financial Advisor Cost?
A commission-based financial advisor doesn't cost you anything—directly, that is. They get compensated by commissions from the products they sell to you or sell for you.
Typical commissions for investment products and packages range from 3-6% of the sale. That sum comes out of the amount that actually gets invested, so in a sense, that commission "costs" you in terms of future returns.
Insurance product commissions, which are taken out of your first-year premium payments, range from 1% to 8% on annuities. On life insurance policies, an advisor may get 40% to 90% of the first year premium as a commission and between 2% to 5% commission from the second to the fourth year.
What's the Difference Between a Financial Planner and a Financial Advisor?
There's definitely overlap between the two. A financial planner is a professional who helps individuals identify and create a system/schedule to meet long-term financial and life goals. Some just advise, and others actually find investment products.
A financial advisor can apply to those who help you plan and also to those who manage the money in your portfolio and investment accounts. Financial advisors can include brokers and investment managers. "Financial advisor" is a broader, more generic term. All financial planners can be considered financial advisors, but not all financial advisors are financial planners.
How Do I Find a Fee-Only Financial Advisor?
Aside from asking around, you can zero in on a fee-only financial advisor by going to organizations that specialize in the same field. The National Association of Personal Financial Advisors (NAPFA) and The Garrett Planning Network both have searchable directories on their websites.
Other, more general advisor organizations offer a good place to start. For example, the Financial Planning Association (FPA) has a database of financial planners that you can search according to location. On their website, you can easily filter the list to highlight fee-only planners—compensation is indicated in their profiles.
The Bottom Line
It is important to understand that the quality of the advice you receive is not solely tied to an advisor’s compensation model. However, the kind of advice you receive may be affected by the advisor’s compensation model. Compensation arising from sales commissions on financial products could cause advisors to recommend products mandated by their employer and/or products generating the highest commissions for the advisor. These products might not always be the best fit for your situation even if they meet the standard of suitability.
Critics of fee-only argue that this sort of arrangement tends to be more expensive. Of course, fees are an up-front expense—but make no mistake, the commissions paid to a financial advisor also come out of your pocket in the form of lower returns on your investment. Fee-only is not a perfect arrangement, but it is generally a bit more transparent and fees charged for advice are more visible. Commissions may be harder to ascertain.
Also, no advisor (or advisor group) can excel at everything. There are times when you may be better off working with an advisor who specializes in certain commission-based products such as a disability or health insurance. You may also want an advisor who is most current on all investment options. However, if you want advice on retirement planning and do not necessarily need to buy a specific product, an advisor who charges fees may be the right choice.