3 Reasons Fee-Only Is the Only Way
Who, then, can you trust?
Your best bet is to start your search among the ranks of “fee-only” advisors.
Fee-only status is by no means a panacea. It should, however, be a requirement in your advisor search.
Below are three reasons supporting my claim. The second may surprise you!
Reason One: Aligned Interests
Even if you find the best-intentioned rep, if they are not fee-only, doubt will always linger—at least, it should! You should question whether or not each recommendation is in your best interest or if there is some other motivation behind it (whether the rep realizes that pressure is there or not).
What a stressful way to operate!
Suppose you’re very sick. (And pretend the medical profession could charge in the same way the financial services industry does.) You have the option to visit one of the following doctors:
Or, suppose you are in need of an accountant.
Sorry for the stretch--I know it doesn’t make any sense. Then again, that is precisely my point!
What are you seeking when you hire a physician, accountant, or attorney to represent or serve you? Most people want to benefit from their impartial expertise.
The search for a financial advisor should be no different. And I believe caring for your financial health is almost as important as caring for your physical health.
If you get paid when you sell a product, you learn the ins and outs of that product. You learn how to pitch it and sell it.
We all have to make a living. From that perspective, those activities that make us the most money are what motivate us.
Commission-based financial representatives, then, are motivated by selling their products.
Fee-only advisors are motivated by selling their advice.
The only way the fee-only advisor will continue to make money is if he can convince you to keep paying him. The only way you will continue to pay him is if his advice truly adds value. One of the best ways the fee-only advisor can generate even more money is if he provides such invaluable advice that you feel compelled to recommend his service to all your friends.
Reason Two: Less Expensive
No, you didn't misread that. Working with a fee-only financial advisor can actually result in lower fees over the long run.
Burton Malkiel, economist and author of A Random Walk Down Wall Street, explains:
Many investment advisors will charge you 1% per year or more to manage your investment affairs. Brokers [remember, that's the title for commissioned reps selling investments -ss] will frequently charge even more, costing you 2% or 3% per year in fees.
In Inside Information, financial services expert Bob Veres wrote:
A client with a $1 million portfolio will pay at least $20,000 more in various hidden costs to a broker than to a fee-only financial advisor, even if both the broker and advisor are charging the same fee amount for the planning and investment work.
The costs of doing business with a commission-based advisor add up over time:
- The ~50-100% upfront insurance commissions
- The ~2-10% ongoing insurance commissions
- The ~5-10% upfront annuity commissions
- The ~2% ongoing annuity fees
- The ~1.5% ongoing investment advisory fees
- The up to 5.75% mutual fund front-load fees
- The ~1% mutual fund ongoing fees
You get the idea—it can be a lot.
Mr. Veres explains the root of the problem further (touching on many subjects I have addressed before). After drawing attention to the fact that a commission-based brokerage firm representative is more beholden to (and, consequently, influenced by) his brokerage firm than to his clients, Veres adds:
And (here's the biggest distinction) the brokerage firm representatives inevitably recommend investment products with a lot of buried, hidden, obscure costs that trickle out of the customer's investment portfolio into those enormous multi-billion-dollar bonus pools.
The biggest difference is, most people don’t realize how much they are paying over time for all this “free” advice...
...whereas the fee-only advisor’s charge is right there in front of the client before engagement, and then again every quarter or every month (depending on billing or statement frequency).
The fee-only model is more open, more transparent...
...and less expensive.
To top it off, investment management fees can be tax deductible! Commissions can not.
Reason Three: No Solution Limitations
We discussed ad nauseam the investment limitations on commission brokers. For them, insurance is the same. It all comes down to which providers (of insurance and investment solutions) are willing to pay sales reps. Those commission-laden products, then, are the only ones the rep--assuming she wants to make money--can recommend.
I have provided two infographics to explore the destructive effects of ongoing fees and loads suggested by these advisors. Additionally, data clearly reveal the negative impact loads have historically had on their funds’ performance, compared to their no-load counterparts.
Thus, a commission-based rep’s only way to get paid is to sell you inferior products.
A commission-based rep’s only way to get paid is to sell you inferior products...
Fee-only planners have no such restrictions. Investopedia sums it up:
In an ideal situation, the primary benefit of a fee-only advisor is that he or she can provide objective advice. At least in theory, these professionals are better able to look at the entire universe of stocks, bonds, mutual funds and guaranteed investment certificates without being swayed by any personal benefits that may come with giving certain recommendations.
I’d add alternative investments (think: real estate, hedge funds, private equity) to Investopedia’s list. Every potential solution to your particular investment or planning scenario is an available option for a fee-only advisor to recommend.
Admittedly, then, their limitation is perhaps their particular knowledge and expertise (a topic for a series of future posts). At least you won't have to worry about the effect a proposal will have on their pocketbook. The advisor gets paid no matter the product recommendation or its manufacturer.
She will continue to make money--and potentially make even more--the better her solutions meet her client’s needs.
The Ideal Model
This does not mean there are no other factors to consider in finding your financial planner. I would posit that the next step in your search should be to evaluate fee-only candidates based on their education and continued growth (we’ll get to that in depth in future posts).
Learn the lay of the financial services land, and understand how the various compensation structures can dramatically affect recommendations.
With interests aligned, long-term expenses reduced, and no limit to solutions provided, the fee-only model is the ideal model for any client.
Fee-only is the only way!
Let me know your thoughts
- Have you ever itemized all the commissions and fees you pay to your advisor and been surprised?
- What other benefits (or disadvantages) have you found from working with a fee-only financial advisor?