The Wall Street Journal described how few investors understand how their financial advisors get paid. According to the article, “The heart of the confusion (is) the disagreement over what signifies proper use of common terms as ‘fee-only’ and ‘fee-based’ – and whether some advisors are forthright enough in their disclosures about their compensation.”
The term “fee-only” is reserved for advisors who only get paid directly from their clients— through a flat fee, a percentage of assets under management, an hourly fee, or a project fee. For example, a fee-only advisor might charge their client an annual fee of 1% of the investments they are managing.
What can become confusing is the term “fee-based.” This term has been adopted by many brokers and agents who acknowledge that fee-only RIAs (who don’t receive commissions to sell financial products) may have fewer conflicts of interest than brokers who have a commission incentive to sell products. Fee-based, by industry standards, means the brokers can charge a fee in addition to collecting commissions.
The confusion goes beyond how people are compensated. Fee-only investment advisors are legally required to work in their clients’ best interest as a fiduciary. In contrast, brokers and agents generally work under a less stringent suitability sales standard, meaning the sale of their product or service only has to be suitable.
If you think this is confusing, consider that some fee-only advisors also have licenses that permit them to receive commissions through a broker-dealer. That means that they fall under a fiduciary standard when they are doing advisory work and a suitability standard when they are doing commission work.
We recommend that you determine how you want to compensate your advisor. You should know clearly if you are the only one paying them or if they are also receiving a commission incentive. Require full disclosure so you can make an informed decision.
For more insight, listen to Jentner Wealth Management’s weekly podcast by clicking here. Or download Jentner’s white papers on The Four Cornerstones of Prudent Investing and The Active Versus Passive Investing Debate.