Independent financial advisers are in the business of assisting you in managing your money or making more. But, let's face it, they're also utilizing your cash to help them make more cash. Advisers can be compensated in a variety of ways, depending on their licensure and profession. Some referred to as "fee-based," charge fees and commissions based on the amount of money they manage. Others, known as "fee-only," are not permitted to make commissions from product sales and must instead charge in other ways. Is it true that either payment mechanism guarantees fair advice? No, that is not the case. The truth is that every pay plan in the financial services business has problems. Let's have a look at how you pay an independent financial advisor, whether it's a fee-only or fee-based arrangement, and see if it has an impact on the advice they provide.
Key takeaways
- Financial advisors who work on a fee-only basis do not collect commissions on the products they sell or recommend.
- Fee-only financial advisors may charge a flat fee, an hourly rate, or a percentage of the assets they manage for you.
- Ask inquiries about their approach to planning to identify an experienced and skilled financial adviser.
The illusion of unbiased advice
The term "fee-only" refers to the fact that your advisor can only be paid directly by you for the services they perform. They are employed by you. They can charge a flat fee for a project, such as assisting you with a financial plan. They can also charge an hourly cost, a percentage of assets managed on your behalf, or a retainer fee for a specific period of time, such as a year or a quarter. An adviser who charges a portion of the assets they manage is the most popular fee-only approach. Here are two examples of how this could lead to a conflict of interest.1) Is it time to pay off your mortgage?
Assume your financial advisor has set up an account to assist you in paying off your mortgage. The more money they have in this account, the more cash they have to work with. If you take money out of the account, they will lose money. Regardless, a smart and honest adviser will do a complete investigation and make a proposal that will benefit your bottom line the most. They should look at your entire financial situation, including your income, assets, tax rates, and ambitions. They'll tell you if they think it's better to liquidate your investments to pay off your mortgage, even if it means losing one of their sources of revenue. Many consultants advised their clients not to pay off their house loans during the heyday of big market returns. They also advised individuals to take out a second home equity loan and put the money into investments. This is contentious since advisors who used this strategy benefited personally when their clients invested their money. Despite the fact that this method would make them more money, a fee-only advisor would be unlikely to recommend it. Why? Because the stakes are bigger if they advise you to do something that is harmful to your health. They are legally responsible for the advice they give, and it must be in your best interests. The same restrictions do not now apply to a commission-based adviser.2) Should you invest in annuities?
As you approach retirement, annuities can provide some distinct benefits. Putting aside a portion of your investing budget to buy an annuity can make sense if you don't have any other reliable sources of income. The majority of annuities are still commissioned. Fee-only advisers must conduct further research to find no-load products with income features for their customers. The term "no-load" refers to products that do not pay a commission. As a result, the buyer pays lower fees for the product. Fee-only advisors have a reputation for being biased towards annuities. This happens for a cause in some circumstances. In other circumstances, the bias arises from the fact that the adviser will make less money if the customer withdraws money from a managed account (for which the advisor charges a fee) and invests it in an annuity. This prejudice must be overcome. The Department of Labor announced in 2016 that annuity sales would be subject to fiduciary duties. Despite the fact that the rule was never enacted, many insurers and investors felt it would boost demand for fee-only insurance. As a result, many innovative no-load annuity products hit the market in the years that followed. As research has supported the usage of annuities, in a cautious quantity, as a smart portion of an income portfolio, sales of these products have continued to climb (by 42 percent in 2018 and another 28 percent in the first half of 2021). In the retirement income phase of a client's life, the correct annuity products can provide value. Fee-only advisers, on the whole, could use some new ideas. Fee-only advisers might do the same with alternative payment structures that fee-based advisors do with annuities.The hourly model
If you can follow through on your advisor's advice, paying them by the hour can be a good option. Hourly advisers have been known to express dissatisfaction with their customers after giving them a list of tasks to complete, only to find that when they meet with them again, the client has not completed any of the action items. People can avoid making costly financial mistakes if they visit with their financial counselors more frequently. Instead, they seek counsel only once in a while or when things are dire and there is a lot to be missed. In other circumstances, though, paying your advisor on an hourly basis makes sense. If you require assistance with a specific subject or analysis, hourly financial planning services might be quite useful. If you want a more holistic approach and are ready to pay for the time it takes for the adviser to provide well-rounded guidance, paying by the hour makes sense.The commission model
The option with the most conflicts appears to be paying your adviser commissions or using a broker-dealer. Indeed, there is little in the banking culture that motivates advisers to conduct independent research and do the right thing for their clients — it's all about making money. A broker's job is to sell, not to provide advice. They were formerly obliged by lax standards to protect their clients, but this varies by state, and regulations are always changing. Nonetheless, unlike counselors, you cannot assume they have a fiduciary duty to operate in your best interests. Some of these consultants and brokers, even those that work on a fee basis, may be lacking in understanding. They were given a securities license and sent out to sell, just like the rest of the counselors. Some of them never went on to get much more education after that. Having said that, exceptional advisers exist in all payment structures, and finding them is the difficult part.Finding your financial advisor
Starting with a registered investment adviser (RIA) can assist protect against some, but not all, potential conflicts of interest. The true goal should be to select a qualified, experienced, and informed advisor who genuinely cares about you and will not put you in danger.Questions to ask a financial advisor:
Here are some things to look for when selecting a financial adviser:- Do they provide a complete planning service or do they only sell a product?
- Is tax planning a part of their advice?
- Do they take a strategic approach to investing, or do they just throw their clients into pre-made programs?
- Are they aware of the complexities of filing for Social Security?
- Do they know how to invest for retirement in a way that is different from how they invest for earnings?
The bottom line
A good independent financial advisor will provide you with honest advice and solutions that suit your goals regardless of how they are compensated. To be an informed customer, you must understand how they are compensated and how that model may influence their advice. You must also ask difficult questions and seek truthful answers. It's a positive indicator if they reveal any potential conflicts of interest right away. During the hiring process, take your time. It doesn't matter how you pay your adviser if you're working with someone you can trust.