What is a Fee-Only Financial Advisor (and why it matters)?

Often times when I mention to prospective clients that I am a fee-only financial planner they give me a sideways look - as if they should know what that is but don't want to ask and have it potentially be a "dumb question." Truthfully, it's not a dumb question at all. Clients should feel comfortable asking how their financial advisor gets paid. They should know if/when their advisor is getting paid a commission per trade and/or is being compensated by recommending moving from one fund or insurance product to another.

In Simple Form:

A fee-only advisor, sometimes called a "no-commission" advisor, only receives compensation directly from the client (like a CPA or attorney) versus being paid commissions from the products they sell. Although no business model is 100% conflict-free, without any products to sell, fee-only advisors at least eliminate the traditional product pushing nature of the industry. For example, human nature loves instant gratification. If there is a choice for an advisor to recommend two similar products, but one pays a higher commission, they're likely to be inclined to choose the product with which they're paid the most. The worst part is that it's often justified by the logic of, "well, the client is still better off than they were before..." Granted, I definitely don't operate under the notion that all commission based advisors are out there screwing over their clients. I'm simply arguing that they should just disclose the commissions paid on each product that they sell. Using whole life insurance as an example, there are ways to design a policy that can turn a $10,000 commission into $1,000 - with a lot of the difference going right into the early year cash value for the client. Human nature obviously plays an impact and causes potential conflict in that case.

Fiduciary Standard:

Fee-only advisors, or fee-only financial planners, almost always operate as fiduciaries. In fact, as a member of XY Planning Network (XYPN), the membership requires a signed fiduciary oath upon joining.

A simple definition of fiduciary is that a person must legally give advice that is in their client's best interest.

Some clients assume that all financial advisors are required to give advice that's in their client's best interest, but it's not true. A lot of financial services professionals that call themselves advisors operate under the "suitability standard."

Suitability means the recommendation must be appropriate based on the client's financial status and goals, but if one product pays the advisor more than the other, but both products are arguably "suitable", the advisor can sell either one and doesn't even have to disclose the commission difference.

How Fee-Only Financial Advisors Get Paid:

A fee-only financial planner cannot receive compensation from a brokerage firm, insurance company, mutual fund company, or any other place except the client.

A fee-only advisor can charge based on a percentage of assets or net worth. They can charge based on a flat fee regardless on the amount of investable assets, or sometimes they even charge an hourly fee.

Fee-Only vs. Fee-Based:

A fee-based financial advisor can receive fees paid by the client AND also receive commissions from products they sell or kickbacks from mutual fund companies.

A lot of times fee-based is a term used when recommending a managed account. Beware that not all manged accounts are created equally. Some may hold proprietary funds or just be flat out expensive. I've seen multiple accounts that have over 2.25% in annual fees all-in. For a $1,000,000 account, that would equate to a whopping $22,500 per year in fees. Make sure you know all parts of the fee - the fee you're paying for investment management AND the internal fees that are part of mutuals funds and ETF's.

With investments becoming a commodity (Fidelity just introduced completely free funds), meaning that you can buy the same investments on almost any platform, the value of an advisor lands in the advice, the actual written financial plan, and a specialization or niche for a specific group of clients.

The bottom-line is that even if you've been working with your advisor for a number of years, it's important to ask whether or not they are a fiduciary and also know what you are paying them.

Lastly, I'll finish up with an example of one of the last cases I came across. The client had worked with their financial professional for a long time and developed a trusting relationship. They had done a few IRA rollover's and paid commissions for the rollovers into actively managed (under performing, expensive A-share) mutual funds. The funds also had over a 1% internal expense ratio. Simply put, they paid 5% of the account balance up front in commissions and then also pay 1% per year. The client then had another $100,000 to add to the IRA from another old employer 401(k). The advisor chose to put the $100,000 into a variable annuity IRA with a 10 year surrender period. The client purchased this when they were 54. They would otherwise be able to access the account at 59-and-a-half, but since they're now in an annuity with a 10 year surrender period they cannot access it. For them to get out of the annuity today it would cost the client $6,000. The best part - the variable annuity has costs north of 2% per year and under performed it's weighted index by a large amount.

Again, even if you've been with your advisor for a long time, with the way that planning and investments are changing, it may be time to consider a second opinion from a CERTIFIED FINANCIAL PLANNER ™ professional.

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