The differences between ‘fee-only’ and ‘fee-based’ advisers

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If you want an adviser whose interests are aligned with yours, it’s important to know the method in which a financial adviser is paid.

One of the most confusing things in the financial-services industry is trying to understand how financial advisers are compensated for their services. Many people I meet with at an initial consultation with investment accounts at other institutions have no idea how they’re financial adviser is compensated.

Financial advisers are generally compensated in one of three ways; commission only, fee only and fee-based. Many investors are aware of the differences between a commission based adviser and a “fee-only” adviser; however, many investors are not aware of the differences between “fee-only” and “fee-based” advisers.

Fee-only advisers

The only source of compensation a fee-only financial adviser receives is from fees paid to them by their clients. Fee-only advisers get compensated in one of two ways: by the hour, or as a percentage of assets they manage for clients. That’s it.

Fee-only financial advisers do not receive any fees, compensation or commissions from mutual-fund companies, brokerage firms or insurance companies. Fee-only registered investment advisers, such as Capital Wealth Management, are legally required and morally obligated to disclose all fees and potential conflicts of interest with their clients.

Fee-based advisers

Unlike fee-only advisers, fee-based advisers are permitted to receive commissions from the sale of certain products in addition to receiving fees from their clients. Common products sold by fee-based advisers include life insurance, annuities load (commission) mutual funds, limited partnerships and wrap programs.

In addition, fee-based advisers are not required to disclose the amounts of their commissions to their clients, nor are they required to disclose any conflicts of interest that may influence a client’s ultimate decisions.

The financial industry is not known for transparency. It can be difficult to find the answers to simple questions, such as how your financial adviser is paid. The following is a list comparing the various forms of compensation between a fee-only and a fee-based financial adviser.

— Can only be compensated by clients: fee only, yes; fee-based, no.– Always required to act in a client’s best interest: Fee only, yes; fee-based, no.– Can receive both fees and commissions: fee only, no; fee-based, yes.– Can receive commissions from mutual-fund companies: fee only, no; fee-based, yes.– Can receive 12b-1 fees from mutual-fund companies: fee only, no; fee-based, yes.– Can receive commissions for selling insurance products: fee only, no; fee-based, yes.– Can receive commissions for selling annuities: fee only, no; fee-based, yes.– Can receive referral fees: fee only, no; fee-based, yes.

Financial advisers deserve to get paid just like any other service. However, if you want an adviser whose interests are aligned with yours, it’s important that you know not only how much your adviser will be compensated, but also the method in which he or she will paid.

Before hiring a financial adviser, ask him or her to provide in writing how much it will cost to hire their services. Be sure to ask for all “fees,” including front-end loads, back-end loads, commissions, 12b-1 fees and any other fees that will make up the cost of their services. Ask them if they are going to be fiduciary in all the services they are going to provide to you 100% of the time.

If the adviser recommends a life-insurance product or annuity, they will provide a written explanation as to why they are recommending it, and why it is in your best interest. At the bottom of the form, designate a space for their signature and date. If they are hesitant or reluctant to sign, you may want to consider looking elsewhere.

Martin Krikorian is president of Capital Wealth Management, a fee-only registered investment adviser at 9 Billerica Road, Chelmsford. He can be reached at 978-244-9254, www.capitalwealthmngt.com, or via email at info@capitalwealthmngt.com.