A friend recently told 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 financial firms, made her money.
What?!?!?! 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?
This topic is germane right now. Earlier this year, the Department of Labor (DOL) announced that the fiduciary rule, which went into effect on June 9, 2017, will phase in through July 1, 2019. This rule mandates 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 new ruling is 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 applies only to advisors working with retirement accounts.
The rule doesn’t apply to advice provided on investments held outside of retirement accounts. That means you will still have to do your homework to find an advisor who has a legal obligation to provide advice that is in your best interest across all your account types. The easiest way to find such an advisor is to seek out a fee-only advisor.
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.
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’s rates are based on a percentage of the assets they manage for you and debited out of your account each quarter, or they charge a flat annual fee or an hourly rate. Make sure you ask a fee-only advisor what services they deliver for their fee. 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 slightly 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 and from 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 good 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.
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