A fee-based investment refers to how a financial advisor is compensated, in particular, the ability to earn a commission by selling a product. This is opposed to a fee-only financial advisor, who cannot accept commissions and must adhere to a fiduciary standard at all times.
Breaking Down Fee-Based Investment
The term "fee-based" is often used to describe a hybrid adviser or dually registered advisor, who can charge fees to certain clients as well as earn commissions by selling products to other clients. "Fee-based" is a term created by brokerages and the insurance industry in response to the success of the "fee-only" classification. Studies have found that consumers find this distinction confusing.
Fee-Based Investments and Clients
"Fee-only" arrangements are widely considered to be better for the client as there is no threat of a conflict of interest, but fee-based advisors may be better for some (usually less-wealthy) clients who might otherwise not be able to afford a fee-only advisor. Fee-based investments and advisors could have a greater incentive to sell a product that offers them the best commission rather than what is best for the client because they need only to meet the less stringent suitability standard. Fee-based advisors must disclose how they are being compensated because of the inherent moral hazard of the commission-based model.
Questions to Ask a Fee-Based Advisor
Would-be clients would be well-served by asking the following questions to be sure of exactly what to expect from a fee-based advisor:
- What are your professional qualifications, and what is your educational background as it relates to dispensing financial advice?
- What is your expertise?
- How are you paid? (fees, commissions or a combination of both)
- Do you adhere to a fiduciary standard?
- Why are you recommending this product to me? Why is it suitable for me?
Fee-Based Investments and Advisors
The appeal of offering fee-based investments has to do with the flexibility it offers financial advisors as well as the potential creation of sustainable revenue via recurring fees. It allows them to continue to serve clients who prefer to stick with the commission model — which often accounts for a significant share of an advisor's revenue — and keep using familiar, tried-and-true products. This is especially true for advisors who may seek to drop their broker-dealer status to move to a standalone RIA model. In such a case they stand to miss out on significant trailing commissions. This consideration is particularly salient, as the ranks of hybrid advisors continue to grow.