Millions of investors count on their financial adviser to help them build wealth. But a tricky little turn of phrase can create confusion among consumers shopping for financial guidance.
It all boils down to the distinction between “fee-only” and “fee-based” advisers. While the two terms sound similar, there are crucial differences.
Craig Lemoine, assistant professor of financial planning at The American College of Financial Services in Bryn Mawr, Pa., does not believe that either the fee-based or fee-only approach is inherently superior.
“Is a piece of cheesecake superior to a piece of chocolate cake?” he asks, adding that both fee-based and fee-only approaches have strengths and weaknesses.
But he says all investors should understand the differences between the models.
“Consumer confusion can lead to trouble, both for the client and adviser,” he says.
The fee-only and fee-based models both involve paying direct or indirect fees to a financial service professional. However, fee-only advisers agree to receive all compensation solely from clients. Typically, these advisers charge clients a one-time flat fee, an hourly fee, an annual fee or a percentage of the client’s assets.
Advisers who agree to be compensated under the fee-only model cannot charge commissions. That helps them steer clear of conflicts of interests, says Samuel Scott, a fee-only planner and president at Sunrise Advisors in Leawood, Kan.
“Everyone wants to have their financial professional sitting on the same side of the table,” he says.
In contrast to fee-only advisers, fee-based advisers can both charge fees and receive commissions.
“Fee-based is similar to saying ‘fee and commission,’ but the word ‘commission’ often has a negative connotation,” Lemoine says.
A recent investigation by Wall Street Journal financial reporter Jason Zweig noted that some fee-based advisers might be misleading customers about how they are compensated.
Zweig found that a small percentage of financial planners who work for brokerage firms and insurance companies sometimes bill themselves as “fee-only” when in fact the firm they work for charges commissions.
Financial advisers who earn the Certified Financial Planner designation cannot characterize themselves as “fee-only” if any “related party” — including the adviser’s employer — receives commissions, Zweig reported.
Lemoine says it is a mistake to assume that a fee-only planner is superior to a fee-based adviser simply because the latter may earn commissions.
For example, he believes the fee-based approach can make more sense for an investor who does not have several hundred dollars to pay an upfront flat fee to a fee-only planner.
“I’ve encountered wonderful financial planners who work only on commissions,” Lemoine says.
Joshua Itzoe, a partner and managing director at Greenspring Wealth Management in Towson, Md., has worked under three compensation models — fee-only, fee-based and straight commission-based.
“It’s important to realize that there are good and bad advisers in all three scenarios,” he says.
Today, Itzoe works as a fee-only planner.
“I have found the fee-only method to be the simplest and most transparent model for clients,” he says.
By contrast, with a fee-based or straight-commission model, “there can often be an incentive to sell one product over another” because the adviser makes more money when selling certain products, he says.
If you want a fee-only adviser, there are a few things you should do, Scott says.
Many financial firms disclose any broker-dealer relationships on their website, says Scott. To avoid fee-based operations, look for language indicating that securities are offered through a “broker-dealer.”
You can also visit the website of the Securities and Exchange Commission and access a company’s Form ADV. This will reveal the firm’s compensation structure.
An easier way to ensure you are getting a fee-only — as opposed to fee-based — adviser is to visit the website of the National Association of Personal Financial Advisors, or NAPFA. All firms that are members of NAPFA meet strict fee-only criteria.
If you want extra protection, Scott suggests asking your adviser to sign a fiduciary oath stating that the adviser pledges to do the following:
Act as a fiduciary 100 percent of the time. This means the adviser will put the client’s interest first, ahead of the interests of the adviser or the adviser’s firm.
Disclose all conflicts of interest.
Accept payment only from the client for services rendered.
Refuse to accept referral fees or commissions that are contingent upon the purchase or sale of a financial product.
“If a financial professional won’t sign a fiduciary oath, (then) they do not act as a fee-only registered investment adviser at all times,” Scott says.