The financial services industry has no shortage of jargon and acronyms that can confuse investors as they try to diligently research what type of financial advisor may be right for their situation. What is a fee-only wealth management firm? Understanding the differences between fee-only and fee-based advisors is important for all investors.
Fee-only vs. Fee-based Financial Advisors: What’s the difference?
Fee-only Wealth Advisors
A fee-only wealth management firm only receives compensation from their clients. Fee-only financial advisors are free from the potential conflicts of interest that other advisors may encounter if part of their pay is based on commissions or sales.
A Fee-only advisor only receives advisory fees from their clients; they do not sell financial products (like insurance or stocks), receive commissions, or other revenues from 3rd parties.
Advisory fees are typically a percentage of assets under management (AUM). Other models include a flat fee, retainer, or hourly, depending on the firm. When advisory fees are calculated as a percentage of the assets that they manage on your behalf, they’re with you when the market goes up – and when it goes down. The fee-only compensation model is often thought of as the most transparent and objective.
Investors are typically more comfortable with the fee-only arrangement because it sets the stage for a trusting relationship to develop. Instead of selling, fee-only advisors can be an objective source of financial advice. Most fee-only wealth managers are also fiduciaries.
Darrow Wealth Management is a fee-only financial advisory firm.
Fee-based advisors can be compensated by client fees and commissions for selling financial products (like insurance or annuities) and securities (e.g. stocks, mutual funds) to their clients. Advisors at large wirehouses or individuals affiliated with a broker-dealer often receive additional financial incentives to push in-house funds and proprietary products. These conflicts of interest are typically disclosed, though not in the most simplistic terms.
The commissions on these products can be substantial which can create concerns about conflicts of interest.
Fee-based financial advisors can also receive a referral fee in exchange for referring a client to another professional, such as a CPA or attorney. This can incentivize the advisor to recommend one professional over another.
Financial Advisor vs. Wealth Manager vs. Financial Planner
There are many names for financial advisory professionals, and unfortunately, there isn’t a strong uniform standard to clarify titles for investors. Generally, these titles (and a long list of others we didn’t include) are used interchangeably.
When looking for a financial advisor, focus on the services the advisor is offering and how it compares to your needs. Typically, a wealth manager implies an ongoing relationship with an advisor and often includes both financial planning and asset management.
A financial planner might offer the same services or planning-only, with or without an ongoing relationship. Similarly, a financial advisor could provide transactional support all the way up to comprehensive wealth management.
Since anyone can hold themselves out to be a financial planner or advisor, additional credentials can help you compare advisors’ qualifications. For example, the CERTIFIED FINANCIAL PLANNER™ professional designation is typically considered the “gold standard” for financial advisors, as the Chartered Financial Analyst® designation is to asset management.
Learn more about our team of CFA and CFP® professionals.
Does a Financial Advisor Always Act in Your Best Interest?
A fiduciary duty always requires an advisor to act in the client’s best interest. Registered investment advisors are held to a fiduciary standard, which means they are always obligated to put their clients’ interests ahead of their own. This is the highest standard of care under the law.
Although many fee-only financial advisors are registered investment advisors (and fiduciaries), it is possible for a firm to be one and not the other.
Recent legislation (the now-defunct Department of Labor’s Fiduciary Rule and Regulation Best Interest (Reg BI) which goes into effect in June 2020) aims to raise the standards for broker-dealers and the “advisors” that work for them. At a high level, under previous rules, brokers operated under a suitability framework, which meant recommendations need only be suitable for the investor, not necessarily in their best interest.
In contrast to fiduciary duty, brokers were obligated to act in the best interest of their employer, not their client. Under Reg BI, brokers will be required to act in the client’s best interest, but at the time a recommendation is made; it is not an ongoing duty of care.
Darrow Wealth Management is a registered investment advisor, so we are always required to act in client’s best interest.
When Is It ‘Worth It’ to Work With a Financial Advisor? Kristin McKenna, CFP® for TheStreet
When speaking with advisors, dig deeper into compensation and fees. Although a fiduciary duty is the most stringent standard, some advisors only need to wear their “fiduciary hat” when providing certain advice.
Adding to the complexity, not all registered investment advisors are fee-only, creating a potential conflict between their role as a fiduciary and ability to make commission-based sales. Always research the advisor and the firm on the SEC.gov or FINRA.org website.
Advantages of Working with an Independent Wealth Management Firm
A truly independent financial advisor has no affiliations with a large brokerage firm. Why is that important? As an independent wealth management firm, we don’t have allegiances to a particular fund family or product. Independence and compensation method help an advisor be objective when making recommendations.
Independence also matters when a client is in need of other services, such as life insurance or banking. As an independent wealth manager, we will make referrals to other professionals when clients need of insurance or other products, based on what we believe will be in the client’s best interest.
The professionals in our referral network have no affiliation with us or compensation agreement. Instead, the referral is based on client need alone.
Advisors with affiliations to a bank, wirehouse, or large asset manager might not be able to make an independent recommendation. Consider, for example, if you walked into a Bank of America branch and asked for the best type of savings account on the market. As you would expect, they’re going to recommend one of their products.
Wirehouses, broker-dealers, and registered investment advisors
Independence is critical in asset management. Independent financial advisors will typically cast a wide net and review a global spectrum of investment options before making any selections. Firms with an affiliation to a broker-dealer and other fee-based advisors will often be loyal to a fund family due to compensation agreements and commissions.
The largest wirehouse full-service brokerage firms today are Morgan Stanley, Merrill Lynch, UBS, and Wells Fargo. Independent broker-dealers include LPL Financial, Ameriprise, and Raymond James. While independent broker-dealers may offer a greater scope of products and funds to advisors on their platform, there are still differences between registered investment advisors, most notably the duty as a fiduciary.
Today, many financial advisory and wealth management firms operate as a subsidiary of another larger, parent firm. For example, Merrill Lynch often has affiliations and partnerships with smaller firms or stand-alone advisors and LPL Financial is comprised of a network of advisors backed by the LPL platform.
Affiliated advisors can still call themselves “independent” or a registered investment advisor, but they will still need to disclose the relationship. This is one reason why it is always important to read the disclosures, such as the ADV.
Many investors will choose a fee-only advisor once they understand the difference in compensation arrangements. Before deciding on a financial advisor, do your homework and ensure you are comfortable with the firm. After all, if you don’t trust the recommendations provided by your advisor, why are you paying for them?
Darrow Wealth Management is proud to be:
SEC-registered investment advisor
A fiduciary always acting in your best interest
Second-generation family business
Predominantly women-led firm