The subject of investment advisory fees can be confusing. A survey by Cerulli Associates found that that that 42 percent of investors had no idea how their financial advisor was compensated. Two of the most common forms of compensation of finacial advisors are fee-only and fee-based. These terms refer to how a financial advisor is compensated. Although they sound very similar, there is a significant difference between the two.
Fee-only financial advisors only earn money through the fees their clients pay them for their service. Fee-only advisors do not receive any fees, compensation, or commissions from mutual fund companies, brokerage firms, or insurance companies. Fee-only advisors are typically compensated in one of three ways; by the hour, a flat fee, or as a percentage of assets they manage. If a financial advisor makes money in any other way, the advisor is not fee-only. Fee-only financial advisors have a fiduciary responsibility to always do what is in their clients best interest. As a result, they invest their clients assets in no-load and index mutual funds that have no commissions, low expenses, and no12(b)1 fees.
Fee-based financial advisors like fee-only advisors have the ability to manage accounts where they charge fees as a percentage of their clients assets. However, unlike fee-only advisors, fee-based advisors are not legally required to always do what is in a clients best interest. As a result they can invest their clients assets into a list of proprieatary mutual fund that pays them a commission and charges high fees. Additionally, fee-based advisors have the ability to receive commissions from selling insurance and annuity policies which may not always be in a clients best interest.
As stated earlier, Fee-only advisors, must legally provide advice that is always in their client’s best interest. You would think that all advisors are required to give advice this way, but that’s not always the case.
The following are some of the actual written disclosures explaining some of the methods of compensation, and potential conflicts of interest of fee-based advisers employed by some of the largest brokerage firms in the United States.
“Our interests may not always be the same as yours.”
“Our financial advisers may benefit financially from fees, commissions and other payments from you and our investment providers”
“Your adviser may have a greater incentive to recommend investments that provide additional compensation to the company and your adviser.”
“We are paid both by you and, sometimes, by people who compensate us based on what you buy.”
The bottom line is that a financial advisor’s loyalty, just like any other employed individuals loyalty, is going to the person who signs their paycheck. And for a fee-only financial advisor, it is the client, and only the client, who signs their paycheck.
Martin Krikorian is president of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford. He is the author of the investment books “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Successful Investor.”