There exists a simple but undeniable truth in the financial consulting and wealth planning industry that Wall Street offers kept as a “dirty little secret” for years. That dirty little, and nearly always overlooked secret is THE METHOD YOUR FINANCIAL ADVISOR IS COMPENSATED DIRECTLY AFFECTS THEIR FINANCIAL ADVICE TO YOU!
You want, and deserve (and consequently SHOULD EXPECT) unbiased economic advice in your best interests. But the truth is 99% of the general investing general public has no idea how their financial advisor is compensated for the suggestions they provide. This is a tragic oversight, however an all too common one. You will find three basic compensation models intended for financial advisors – commissions dependent, fee-based, and fee-only.
Commission Centered Financial Advisor – These experts sell “loaded” or commission paying products like insurance, annuities, plus loaded mutual funds. The payment your financial advisor is generating on your transaction may or may not be disclosed to you. I say “transaction” because that is what commission based financial experts do – they facilitate TRANSACTIONS. Once the transaction is over, you may be lucky to hear from them again because they have already already earned the bulk of whatever percentage they were going to earn.
Since these types of advisors are paid commissions which might or may not be disclosed, and the amounts may vary based on the insurance and expense products they sell, there is an inherent conflict of interest in the financial advice given to you and the commission these financial advisors earn. If their income is dependent on transactions and selling insurance and investment products, THEY HAVE A FINANCIAL MOTIVATION TO SELL YOU WHATEVER PAYS THEM THE HIGHEST COMMISSION! That’s not to say there aren’t some honest and honest commission based advisors, but clearly this identifies a conflict of interest.
Fee Based Financial Advisor – Here is the real “dirty little secret” Wall Street doesn’t want you to learn about. Wall Street (meaning the firms and organizations involved in buying, promoting, or managing assets, insurance and investments) has sufficiently blurred the particular lines between the three ways your financial advisor may be compensated that 99% of the investing public feels that hiring a Fee-Based Financial Consultant is directly correlated with “honest, honest and unbiased” financial advice.
The truth is FEE-BASED MEANS NOTHING! Think about it (you’ll understand more when you learn the 3rd type of compensation), all fee-BASED means is that your financial advisor can take charges AND commissions from selling insurance and investment products! So a “base” of their compensation may be tied to a percentage of the assets they control on your behalf, then the “icing on the cake” is the commission income they can potentially earn by selling you commission driven investment and insurance products.
Neat little marketing trick right? Lead off with the word “Fee” so the general public thinks the settlement model is akin to the likes of lawyer’s or accountants, then add the word “based” after it to cover their tails when these advisors sell a person products for commissions!
FEE JUST Financial Advisor – By far, the most appropriate and unbiased way to get economic advice is through a FEE-ONLY economic advisor. I stress the word “ONLY”, because a truly fee ONLY economic advisor CAN NOT, and WILL NOT accept commissions in any form. A Fee-ONLY financial advisor earns FEES by means of hourly compensation, project financial preparing, or a percentage of assets managed on your behalf.
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All fees are in monochrome, there are no hidden forms of settlement! Fee-Only financial advisors believe in FULL DISCLOSURE of any potential issues of interest in their compensation and the economic advice and guidance provided for you.
Understanding the conflict of interest in the economic advice given by commission based agents enables you to clearly identify the issue of interest for fee-based financial experts also – they earn fees AND commissions! Hence – FEE-BASED MEANS NOTHING! There is only one accurate way to get the most unbiased, honest and ethical advice possible and that is through a financial advisor who believes within, and practices, full disclosure.
Payment and Fee-Based financial advisors generally don’t believe in or practice full-disclosure, because the sheer magnitude of the the particular fees the average investor/consumer pays would surely make them think twice.
Consider to get a moment you need to buy a truck specifically for towing and hauling heavy loads. You go to the local Ford dealership and talk to a salesperson – that salesperson asks what type of vehicle you have in mind and shows you their line of vehicles. Of course , to that salesperson who makes a commission when you buy a vehicle – ONLY FORD has the correct truck for you. It’s the best, it’s the only way to go, and if you don’t purchase that truck from that salesperson you’re crazy!
The fact is Toyota can make great trucks, GM makes great trucks, Dodge makes great trucks. The Ford may or may not be the best pickup truck for your needs, but the salesperson ONLY teaches you the Ford, because that’s ALL the salesperson can sell you and make a commission from.
This is similar to a commission based financial advisor. When they sell annuities, they’ll show you annuities. If they sell mutual funds, just about all they’ll show you is commission spending mutual funds. If they sell life insurance, they’ll tell you life insurance is the treatment for all of your financial problems. The fact is, whenever all you have is a hammer… everything appears to be a nail!
Now consider for the moment you hired a car buying advisor and paid them a set fee. That advisor is an expert and stays current on all of the new vehicles. That advisor’s just incentive is to find you the most suitable truck for you, the one that hauls probably the most, tows the best, and is clearly the best option available. They earn a fee for their service, so they want you to definitely be happy and refer your family and friends to them. They even have special preparations worked out with all of the local car dealers to get you the best price on the truck read that right for you because they want to add worth to your relationship with them.
The example of a “car buying advisor” is comparable to a Fee-Only financial planner. Fee-Only financial advisor’s use the best obtainable investments with the lowest possible price. A Fee-Only financial advisor’s just incentive is to keep you happy, in order to earn your trust, to provide the best financial advice and guidance utilizing the most appropriate investment tools and planning practices.
So on one hand you have a vehicle salesperson who’s going to earn the commission (coincidentally the more you pay for the truck the more they earn! ) to sell you one of the vehicles off their lot. On the other hand, there is a trusted car buying advisor who shops all of the vehicles to find the most appropriate one for your specific needs, then because of his relationships with all of the car dealers can also get you the best possible price on that vehicle. Which would you like?
Truly unbiased financial advice plus guidance comes in the form of Fee-Only financial planning. You know exactly what you’re paying and what you’re getting in come back for the compensation your Fee-Only economic advisor earns. Everything is in monochrome, and there are no hidden agenda’s or conflicts of interest in the guidance given to you by a true Fee-Only financial advisor!
The fact is unfortunately less than 1% of all financial advisor experts are truly FEE-ONLY. The reason for this? There’s a clear and substantial difference in a financial advisor’s income generated through commissions (or commissions and fees), and the income a financial advisor makes through the Fee-Only model:
Example #1 – You just changed employment plus you’re rolling over a $250, 000 401k into an IRA. The commission based advisor may sell you a variable annuity in your IRA (which is a very poor planning technique in most cases and for many reasons) and earn a 5% (or often times more) commission ($12, 500) and obtain an ongoing, or “trailer” commission of 1% (plus or minus) equal to $2, 500 per year. The Fee-Only financial advisor may charge you a fee for retirement plan, a good hourly fee, or a percentage of your portfolio to manage it. Let’s say in this case you pay a $500 pension plan fee and 1 . 25% of assets managed (very common for a Fee-Only financial advisor within this situation). That advisor earns $500 plus $3, 125 ($250, 000 * 1 . 25%) or TOTAL COMPENSATION of $3, 625 — FAR LESS THAN THE $15, 000 THE COMMISSION (or Fee-Based) financial consultant earned! In fact it takes the Fee-Only financial advisor over four years to earn what the commission (or fee-based) advisor earned in one yr!
Example #2 – You’re outdated and managing a $750, 000 nest egg which needs to provide you income for the rest of your life. A fee-based economic advisor may recommend putting $400, 000 into an single premium immediate annuity to get you income and the other $350, 000 into a fee-based managed mutual fund platform. The annuity may pay a commission payment of 4% or $16, 1000 and the fee-based managed mutual finance portfolio may cost 1 . 25% for total compensation of 20 dollars, 375 first year (not such as the “trailer” commissions). The Fee-Only consultant would possibly shop low load annuities for you, possibly put the entire portfolio into a managed account, possibly take a look at municipal bonds, or any other selection of options available. It’s hard to say how much the Fee-Only advisor would make as their largest incentive is to keep you the client happy, and provide the best planning advice and guidance possible for your situation. BUT , in this case let’s just assume that a managed mutual fund profile was implemented with an averaged price of 1% (very common for that amount of assets), so the Fee-Only financial consultant earns roughly $7, 500 per year and it takes that financial consultant THREE YEARS to earn what the fee-based financial advisor earned in ONE YEAR!
The prior examples are very common in the current financial advisory industry. It’s unfortunate that such a disparity in earnings exists between the compensation models, or there would likely be many more truly independent and unbiased Fee-Only economic advisors today!
Now consider for the moment which financial advisor will work harder for you AFTER the initial consultation services an planning? Which financial advisor must consistently earn your trust and add value to your financial and investment planning? It’s apparent the financial advisor with the most to shed is the Fee-Only advisor. A Fee-Only financial advisor has a direct loss of income on a regular basis from losing a client.
The commission or fee-based financial advisor however has little to shed. You can fire them after they have already put you in their high payment products, and as you can see from the illustrations they’ve already made the majority of the commission rates they’re going to make on you as a client. They have little to gain by ongoing to add value to your financial plus investment planning, and little to shed by losing you as a customer.
Wouldn’t you prefer a financial advisory design where your financial advisor must continually earn your trust plus add consistent value to your planning?
It’s clearly more difficult to earn a living and run a profitable financial advisory firm through the Fee-Only financial preparing and guidance model. For this reason, many financial advisors take the easy method and sell products for commissions and charge fees on assets managed – that way they can make a fine living on your investment portfolio but still have an ongoing stream of income every year. For this reason also, less than 1% of financial advisors are truly Fee-Only, yet it’s that 1% that is truly objective and unbiased, and that 1% whose only incentive is to manage your financial strategy, investments, and overall wealth to achieve the goals you wish to achieve!
The real “dirty little secret” Wall St has is the undeniable truth how the commission and fee-based financial advisory model has inherent conflicts appealing, and your advisor may be “selling you investment products” rather than “solving your own financial problems”!
Greg Phelps is a CERTIFIED FINANCIAL PLANNER (TM) plus Retirement Financial Advisor in Las Vegas and Henderson, Nevada focused on delivering clients exceptional financial advice and guidance on a Fee-Only basis. Greg has 14 years of financial advisory experience and is an accomplished advisor, writer, and speaker. Greg has worked for 2 of the largest investment banking companies on Wall Street – Morgan Stanley and Goldman Sachs, along with serving as the Regional Manager of Wealth Management at the 5th largest accounting firm in the country – RSM McGladrey.