There is often a lot of confusion over the difference between different types of financial advisors and how they charge you fees. Really, there are two main types: fee based financial advisors and fee only advisors.
Now, is this really just semantics or is there a true difference between the two? And if there is a difference does it really make a difference to you?
As a matter of fact the distinction between fee based financial advisors and fee only is very important. The term fee is confusing to people looking for an advisor.
Brokerage firms are capitalizing on this confusion. “Fee based financial advisors” are something created to lull people into thinking they have one thing – a fee-only advisor. In fact, they have something quite different.
Whaaaat?
Let’s look at the difference between a “fee based financial advisor: and a “fee-only financial advisor.” Understanding the difference between the two will help you build your net worth over time.
Fee-only Financial Advisors
We’ll look at the “fee only” designation first.
Fee-only planners work only for the client and are compensated only by the client. The fee-only financial planner has no other interests.
A fee-only planner will not:
- Sell additional products
- Receive commissions
- Get compensation from mutual fund families for having clients use their products
- Be compensated for referrals to other professionals (e.g. insurance providers, attorneys or loan experts)
- Get compensation for meeting quotas (e.g. selling a high volume of annuities or life insurance)
In other words, they are fiduciaries of the clients they work for. They are payed an hourly wage, or some sort of fixed yearly fee for ongoing work. They will not earn a bonus for selling a certain product.
This is an important distinction because they do not have a conflict of interest. There is no reason for them to recommend an investment, other than being best for their client.
Fee Based Financial Advisors
Advisors who put forth themselves as “fee-based” are not required to adhere to any one set of principles when determining how to charge their clients. Nor do they need to even adhere to any one set of principles about who to accept compensation from.
Fee based financial advisors may be compensated by the client and any of the earlier mentioned ways. They benefit from commissions, bonuses for making quotas, kickbacks for referrals, etc.
You need to understand that fee-based advisors are not fiduciaries. Burn that into your brain. Brokerages use the term “fee” to deceive you. They want you to believe that the term “fee-based” indicates you are consulting with a Fee-Only advisor.
Fee-Based Does Not Equal Fee-Only
What you are doing when working with a “fee based” financial advisor is working with an advisor that is part of the same old commission-based scheme. They make money every time they recommend that you invest in something.
For instance, they will have a real conflict of interest with the products they advise you to purchase because they make money from them, and the products that pay the highest commission are that way for a reason.
They can’t sell themselves. So, these advisors get put in a spot where they need to choose whether to feed their kids or do the right thing for your financial future. This conflict of interest is what makes it so difficult for you to get ahead with a fee-based advisor.
In addition, they can charge percentages of assets under management and put a real drag on your portfolio. Also, with buying bonuses, they are incentivized to have you buy and sell frequently. This incurs higher costs and taxes to you.
Lastly, they often work for much larger corporations that limit what they can offer to only their company’s funds even if there is a better product available elsewhere. Fee-based advisors will end up being more expensive, charge higher fees, and limit how much you can earn off your investments.
How Do I Know I’m Working with A Fee-Only Advisor?
The best way to ensure you really are working with a fee-only advisor is to ask for their National Association of Personal Financial Advisors (NAPFA) creds.
NAPFA is the representative organization for the majority of “true” fee-only financial planners.
If an advisor wants to qualify for NAPFA membership, he or she must submit a financial plan, take an oath to be a fiduciary in all client relationships, and then comply with annual continuing education requirements.
This is not an easy membership to obtain. Not all fee-only planners join.
But you can rest assured that if your advisor is a NAPFA member, then they are a “real” fee-only advisor.
You can still hire a non NAPFA fee-only advisor – just ask him or her to sign a fiduciary oath for all of your financial transactions.
Fee-Only vs Fee-based Financial Planners
There are a few distinct differences between how financial advisors charge their clients. While it can sound like a small difference, picking the right one can make a big difference.
Fee-only financial planners are fiduciaries for their clients.
Fee based financial planners are not – they accept commissions, get compensated for using products and sell additional products. To top it off there aren’t rules that govern the use of the description “fee-based”.
Make sure you get what you really want by checking your advisor’s designation. Picking a fee-only financial planner can help you save money in the long term and grow your wealth.
Better yet, learn more about your own finances and take control by being your own advisor. As you learn more, you’ll be able to leverage your knowledge into more money.
Financial advisors are a great way to preserve and grow your wealth. However, be aware of how they make money so that you can control what you pay. Saving even 1% a year can add up to hundreds of thousands of dollars over the years.
