Should you be working with a fee-only financial advisor? There is a lot of confusion about how to select a financial advisor as well as how different compensation models can affect the advice an advisor provides.

Compensation Model

There are a lot of labels used in the financial services industry, such as fee-only. Unfortunately, these labels are not clear cut and often subject to interpretation by different advisors and companies.

The basic compensation models for advisors are:

  • Advisors who only charge 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 on-going.

  • Advisors who charge based on assets under management, for example, 1% of the investment account value. The engagement may or may not include planning and/or other advice which is secondary to the investment management.

  • Advisors who only receive commissions based on the sale of a product or a financial transaction, such as a stock trade. Any advice or planning are ancillary to the product sale.

Is Fee-only the Best Option?

Many recommend that you only work with an advisor who charges a fee. The rationale being they are acting as a fiduciary and required to act in the client’s best interest. Whereas an advisor who only earns commissions is held to a lower standard and does not have to make the ‘best’ recommendation, but rather one that is ‘suitable’ for your needs. (See also: Choosing A Financial Advisor: Suitability Vs. Fiduciary Standards.)

Since fee-only advisors do not sell commission-based products, receive referral fees, or other forms of compensation, the potential for conflicts of interest is limited. And this may be true, but there are pros and cons to the fee-only model. 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, which is revenue not going to the fee advisor.

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 be prohibitive. Potentially limiting many people’s access to advice.

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 disability or health insurance, and understands the available products. Also, some states limit an advisor ability to charge a fee for the analysis of just insurance products or needs.

Fee and Commission Model

As an alternative, many advisors use a model in which they are compensated through a combination of fees, assets under management and/or commissions. The exact mix varies by advisor. This model allows advisors to offer clients a wider range of services as well as work with them to implement recommendations and monitor progress. Also, the advisor has the flexibility to work with a broader range of clients whose needs and resources differ. However, the model can be confusing since some of the time the advisor may be acting as a fiduciary; while on other occasions, the advisor has no fiduciary responsibility.

Fiduciary Responsibility

A potential solution is not to focus only on the compensation and instead consider working with an advisor who has fiduciary responsibilities as part of the engagement. Generally, an advisor is a fiduciary when they charge a fee for planning services and/or are investing money in an advisory account. Also, Registered Investment Advisors and Certified Financial Planners act as a fiduciary.

 At the initial meeting, an advisor who fits this model should among other things:

  • Explain how they are compensated.

  • Demonstrate their ability to act as an independent insurance broker when recommending products (See also: Independent Agent)

  • Provide written disclosures about any potential conflicts of interest as well as other sources of compensation, such as referral fees.

  • Provide a clear written statement that any client who engages them for planning services is free to implement the recommendations of the advisor or elsewhere.                                                                                             

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. For example, as the parents of a newborn you may want to buy additional life insurance. Thus, working with an independent insurance broker may be a better choice than an advisor who charges a fee. However, if you want advice on retirement planning, and do not necessarily need to buy a specific product, an advisor who charges planning fees may be the right choice.

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