Do you know how your financial advisor is compensated?
A lot of people don’t. And maybe you don’t care. But you should. It can impact your wealth and the quality of advice you receive.
I heard about this first hand from a friend recently. She shared with me that her MBA-degreed 60 year-old-brother, Michael, admitted he didn’t know how his financial advisor Meg, affiliated with one of the country’s top brokerage firms, made her money. Michael, with $3,000,000 in investments, is a pretty savvy fellow. How could he not know how Meg earns her keep? Is she a fee-only advisor that legally must put her client’s interests first, or a commission-based advisor that may at times have a conflict of interest between what will pay her the most and what will be best for Michael?
Based on the firm Meg works for (which shall remain anonymous) it’s a safe bet that she is a commission-based financial advisor. She likely receives some compensation from the financial products she recommends to her clients. I haven’t asked my friend, but I speculate that Michael has been sold a fair amount of high-priced actively managed funds and variable annuities.
Perhaps Michael would be better served by engaging with a fee-only “no commission” advisor. Such an individual cannot receive commissions from product sales. Having no commissions helps reduce conflicts of interest with the advice the advisor gives.
This topic is germane right now. Some regulators think it is so important that in 2016 the Department of Labor (DOL) announced a new rule called the fiduciary rule, which was supposed to phase into effect from 2017 to 2019. The courts threw it out, and now other government agencies are working on altered versions of it.
The rule would have mandated that all financial professionals who work with retirement plans or provide advice on retirement accounts act as a fiduciary. A fiduciary is a person who is legally bound to give advice that is in the best interest of his or her client. The gist of the rule was that brokers must put their clients’ interests before their own when handling retirement accounts. (It pains me that this is something that needs to be said, let alone ruled on by the government.)
Note: the new fiduciary rule would have applied only to advisors working with retirement accounts. The rule would not have applied to advice provided on investments held outside of retirement accounts. That means even if that rule had passed, you would still have homework to do to find an advisor who has a legal obligation to provide advice that is in your best interest across all your account types.
Rather than wait for the government to come up with a consistent rule, the easiest way to find an advisor who is a fiduciary is to seek out a fee-only advisor.
How fee-only services work
With a fee-only advisor or firm, their compensation comes from you – you hire them to provide a service. Contrast this with someone who works for a bank, brokerage firm, or insurance company, where the company hires the advisor to sell products to you.
I think it makes sense to seek out fee-only advisors. After all, if you consider where someone’s paycheck comes from, that tells you quite a bit about where their loyalty lies.
A fee-only advisor typically has rates based on a percentage of the assets they manage for you, or they charge a flat annual fee, or an hourly rate. Make sure you ask a fee-only advisor what services are included in their pricing. Some only manage a portfolio while others provide comprehensive financial planning and tax planning in addition to portfolio management. Expect to pay slightly less for advisors focused only on investment management, and somewhat more if comprehensive planning services are also part of the package.
The folks who propose that commission-based services are best often argue that you may pay more over time with a fee-only advisor vs. a one-time commission for a product that you buy and own for many years. I understand this viewpoint – but in reality, many commission-based advisors try to move their clients into new products every few years, thus generating more commissions, and in many cases costing more than a fee-only advisor who charges a percentage of assets. Even if it doesn’t cost more, the client often loses out by being in products that the brokerage firm wanted to push that year – even though that wasn’t the best choice for the client’s goals.
Fee-based is different from fee-only
Fee-based is not the same as fee-only. Fee-based financial advisors can receive compensation from fees paid by you andfrom commissions paid to them by a brokerage firm, mutual fund company, insurance company, or investment partnership. Make sure you know what these fees are.
Even though both fee-only and fee-based financial advisors may have accounts they manage where they charge a percentage of the assets, the investments they place inside these accounts can be very different. Fee-only financial advisors have a fiduciary responsibility to choose investments that are in your best interest. They typically use investments that have low internal expenses, such as no-load mutual funds, stocks, and bonds; investments that have no 12(b)1 fees. A fee-based advisor may use higher-fee investments inside the fee-based account as they have no obligation to try to find the options that are in your best interest.
Be aware that many advisors who are “fee-based” recommend clients invest in a managed account. A managed account (also known as a “wrap account”) is a type of investment management service that packages together a group of investments for you. Some managed accounts offer a fair service for the price; others have high fees and tax inefficiencies. The challenge is figuring out which is which. For example, the financial products offered inside a managed account may pay incentives to the company the advisor works for, which means it may not be as objective as it appears.
And now a word from Tony Robbins
I’ll let Tony Robbins have the last word about fees. He cautions that many advisors register as both fiduciaries and brokers, so it’s not clear whether, and when, they’re acting in the best interest of their clients.
What should you and Michael, my friend’s brother, do? Ask your financial advisor how they are compensated. If the answer is murky, walk away and find someone who will directly answer the question of how they earn their money.
Here at Sensible Money, we are fee-only advisors who are fiduciaries. We cannot receive compensation from any product sales. We prefer it that way. We want our sole focus to be delivering advice that is in our client’s best interest.
For more tips on planning for retirement and finding quality advice, sign up for our free monthly Financial Sense newsletter where we keep you informed about upcoming podcasts as well as free online retirement classes.
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