The Truth About Financial Advisor Compensation: Fee Based vs Fee Only Financial Advisors

The Truth About Financial Advisor Compensation: Fee Based vs Fee Only Financial Advisors

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01:30 Fee Only Advisors
2:19 Fee Based Advisors
2:54 Fiduciary vs Suitability Standard
3:44 How to verify an advisors compensation structure

Financial Advisors’ compensation influences their incentives and ultimately dictates the quality of their advice. Advisors either receive commissions OR are paid by the fees their clients pay them. The confusion arises when advisors are compensated by the fees their clients pay WHILE ALSO receiving commissions from the sale of financial products.

Because the financial advising industry is so opaque, not all advisors are forthcoming about how they are paid. You may wish to seek out a fee only advisor (who does not receive commissions in any form) but mistakenly work with a fee based advisor (who will receive fees AND commissions). It’s easy to see how that mistake might be made given how similar the terminology is…

When an advisor is paid commissions, they are not working for you, the client. They are working for a company (brokerage, bank) that incentivizes the advisor to sell a PRODUCT. As a consumer, you want to know if your advisor is working for YOU or working for SOMEONE ELSE when they present themselves to you. To identify who the advisor is REALLY working for, I recommend focusing on these three things:

WHAT IS A FEE ONLY FINANCIAL ADVISOR AND HOW ARE THEY PAID?
Fee only financial advisors are only compensated by you, the client, and NEVER receive any form of commission. How the fee only advisor is paid can differ by advisor - it can be charged as a flat fee, an hourly rate, or a percentage of assets under management. Fee only advisors may also offer a range of services that include financial planning, investment management, or ongoing advice. The key thing to note here is that because the advisor only gets paid by YOU, they therefore work exclusively for you.

WHAT IS A FEE BASED FINANCIAL ADVISOR AND HOW ARE THEY PAID?
Fee based advisors are compensated via a combination of the fees you (the client) pay, as well as commissions for selling financial institution products such as insurance or mutual funds. Fee based advisors may offer services like investment management, financial planning, or ongoing advice (similar to fee only advisors), but will also position and sell life insurance products, annuities, firm proprietary products, and mutual funds.

FIDUCIARY VS SUITABILITY STANDARD
Fee based advisors are held to a “suitability” standard. The suitability standard requires that investment products such as an annuity or a mutual fund sold for a commission must be suitable for the client but need not be the best possible investment product to meet the client's needs.

Fee only advisors are held to a “fiduciary” standard. The fiduciary standard requires that the advisor put their clients’ interests first and foremost. Part of “putting clients interests first and foremost” requires eliminating bad incentives such as commissions that could sway the advisor to recommend something less than the best possible solution for the clients’ needs.

HOW TO VERIFY AN ADVISORS COMPENSATION STRUCTURE
Most clients can spot a commission only advisor. Your gut tells you to go with an advisor who is paid by you and not big banks or product placement firms. But still, it’s extremely difficult to tell between fee only and fee based advisors, especially when the advisor in questions isn’t 100% transparent.

Check their Form ADV. Form ADV is a compliance document hosted by state or federal regulators that lists how the advisor is compensated, the size of the practice, what other business activities they might participate in, and whether any disciplinary action has been levied against the company.

Do some research. Most fee only advisors will be listed on fee only trade organization websites such as FeeOnlyNetwork.com, NAPFA, XYPN, or the CFP website. If you cannot find the advisor on one of those listings, it’s likely that the advisor is fee based rather than fee only.

Ask the advisor directly. If the advisor isn’t forthcoming or transparent, well that’s all you need to know about their quality of character.

IN CONCLUSION
Fee only advisors are typically investment advisor representatives at independent smaller advisory practices known as Registered Investment Advisors, are held to a fiduciary standard, and may be Certified Financial Planners™.

Fee based advisors typically work for large banks, insurance companies, or institutional firms such as Ameriprise, JP Morgan, Morgan Stanley, or Northwestern Mutual. The advisor will usually be titled a “Registered Representative”, held to a suitability standard, and may have a series 6 or 7 license.