Fee-Only Financial Advisor or Fee-Based Financial Advisor: What’s the Difference?
There are a few ways that financial advisors receive compensation. One involves flat fees, one is strictly commission-based, while some advisors are compensated via a combination. So which should you choose?
You look to your financial professional for financial and investing recommendations, but did you know that the way your wealth advisor is compensated may have a bearing on their recommendations?
Here’s what you need to know about these three basic ways that advisors are compensated:
- Fee-only
- Fee-based
- Commission-based
Fee-Only Financial Planners/Advisors
Fee-only advisors are paid an established rate for services directly by their clients. They aren’t paid by earning commissions from the sale of financial products. Benefits of working with this type of advisor may include reduced conflicts of interest, no surprise charges, transparency in fee structure, and the advisor acting as a fiduciary (meaning they must act in their clients’ best interests at all times).
However, fee-only advisors do have some limitations in their product and service offerings. For example, they may not be able to sell life insurance, and would need to refer you elsewhere. Their compensation is also often based on a percentage of assets under management (AUM). This could possibly present certain conflicts of interest if, for example, you wanted to withdraw a large amount of funds.
Fee-Based Financial Planners/Advisors
Fee-based advisors are paid by the client, which constitutes the biggest portion of their income. They will collect a pre-stated fee for services, which may include a retainer, flat fee, or an hourly rate.
They also receive a small percentage of their revenue from other sources, including commissions on selling products like insurance.
Just like fee-only advisors, fee-based advisors also act as fiduciaries, adhering to a stringent level of care and responsibility to their clients. There is also transparency in fees, which is part of the fiduciary standard.
Another benefit: Fee-based advisors have access to more investment options and products that they can recommend to their clients.
At Ironwood Wealth Management, we are a fee-based financial planner. In our business, 99% of what we do is fee-only, but we do earn commissions from insurance sales, which make up 1% of our business. This gives you access to more options, and allows us to operate in such a way that our relationship with you comes first, not compensation.
Commission-Based Financial Advisor/Planner
The final model is commission-based. A commission-based advisor’s entire income comes from financial and insurance products clients purchase, or when clients open an account. Compensation can come in the form of upfront sales fees on mutual funds, commissions from annuities or insurance sales, as well as trailing commissions and surrender charges (if an investor sells a product before a specified time period).
Some investors may worry that commission-based advisors are only interested in selling clients products that are lucrative for the advisor. While this has been shown to be the case with some commission-based advisors, these advisors must not conceal potential conflict of interests and must disclose all fees and commissions in dollar form to clients. This disclosure comes in the form of a Best Interest Contract Exemption (BICE).
Which of the three compensation structures is right for you?
While we can’t make that determination for you, here are four important questions you should ask of any financial advisor you are considering working with.
Who is your ideal client? Look for an advisor that specializes in working with others whose financial situation is similar to yours.
How are you compensated? Make sure you understand how you’ll be charged based on their compensation model, and ask for an itemization of fees and expenses in writing. A trustworthy financial advisor will be transparent with you.
What are your qualifications and credentials? We believe that there are two important credentials to look for: CFA (Chartered Financial Analyst) and CFP (Certified Financial Planner). These designations require rigorous education and examinations, along with adherence to stringent codes of ethics and guidelines.
Are you a Registered Investment Advisor? RIAs are registered with the U.S. Securities and Exchange Commission (SEC) and are bound by fiduciary duty, always bound to the highest standards of care and to act in a client’s best interest. They are also completely independent, not tied to any broker-dealer incentives, sales quotas, or proprietary products. (Note that Ironwood Wealth Management is an RIA).
Learn more about how Ironwood Wealth Management, and RIA and fee-based financial advisor, can help you create a comprehensive financial plan that is in line with your financial goals and that always keeps your best interests top of mind. Contact us today.