When it comes to working with a financial advisor, most would-be investors are used to the idea of a commission-based model, in which an advisor earns commissions from specific stock trades. With this model, investors often don’t directly pay the financial advisor, which can seem like a great deal. Instead, the advisor’s income comes from commissions earned through completed investment transactions.
However, as Fulton Brock, president of Brock Asset Management explains, many investors would actually be better served by working with a fee-only financial advisor instead. As his insights reveal, there are several distinct advantages of working with a fee-only financial advisor that can help individuals make the most of their investments.
Reduced Conflict of Interest
One of the biggest potential concerns with a commissions-based financial advisor is the potential for conflict of interest. Commission-based advisors may receive referral fees, commissions and other forms of compensation that heavily influence what investments they recommend.
“When an advisor earns commissions based off their sales, they are often incentivized to have a customer invest in a particular fund, even if it doesn’t align with the investor’s goals,” Brock explains.
“On the other hand, when working with a fee-only advisor, that incentive doesn’t exist. The advisor is paid the same amount, regardless of which products the investor chooses to invest in. While this doesn’t fully eliminate the potential for conflicts of interest, it does help reduce the likelihood of such conflicts. Fee-only advisors are independent, which can be important for building and maintaining trust.”
As a report from the CFA Institute Research & Policy Center notes, commission-based advisors are often registered as both broker-dealers and investment advisors to maximize their earnings potential under a commission-based system.
However, their customers are largely unaware of the differences in the standards for when their advisor acts as a broker versus an advisor and how that affects them. This makes it all too easy for conflicts of interest to result.
A fee-only focus allows meetings with advisors to focus more on providing the highest-quality investment advice rather than trying to sell a specific product. This can better serve clients with comprehensive, big-picture planning where discussing a specific investment isn’t necessary. Advisors won’t be compelled to try to “sell” an investment and can instead focus on offering advice and finding investments that best suit each client’s individual goals and needs.
Held to Higher Standards
As noted above, one of the most common issues new investors run into is understanding the difference between advisors and brokers, and the standards they are held accountable to.
“A fee-only advisor is required to follow the fiduciary standard, meaning they are obligated to act in the best interest of their clients,” Brock says. “Commissions-based brokers, on the other hand, are held to a lower ‘suitability’ standard, meaning their suggestions only have to be ‘suitable’ for your needs. They technically aren’t required to suggest the best course of action for you. In the long run, this lower standard could lead to significant missed opportunities for investing growth.”
Most notably, the fiduciary standard places a legal obligation on financial advisors to place client interests ahead of their own — something that doesn’t exist with the suitability standard. The duty of care and loyalty to the client required by this standard ensures that investors get the best possible advice.
“Fee-only advisors earn all of their revenue directly from their clients,” Brock adds. “Ultimately, it’s in the advisor’s best interest to support the best interests of their clients. When client portfolios grow, it benefits both the client and advisor, creating a win-win as clients achieve their financial goals and advisors build long-term relationships.”
Fee Transparency
Fee transparency is another inherent advantage of working with a fee-only financial advisor. Fee-only advisors typically charge either a flat rate or an hourly fee for specific planning services. Rates can vary based on the scope or type of the advice being offered, as well as whether it is for a one-time or ongoing service.
Another common method of compensation for fee-only advisors is to charge a percentage based on the client’s assets under management — the amount of money the advisor manages for the client. Regardless of the specifics, this transparent approach makes it easier for prospective investors to compare the costs of services with different advisors.
“Fee-only services are much more straightforward and easier to understand than commission-based products,” Brock says. “With a fee-only service, what you pay for is clearly stated upfront. You know going into any meeting what the fee will be. This can be especially helpful for situations such as getting a second opinion on your financial situation, or for one-off projects like reviewing your financial portfolio or making a financial plan. It creates a more flexible environment that can specifically cater to your needs and budget.”
With commissions, how much an advisor is paid is directly tied into the specific financial products and investments an individual owns. This can make it difficult to determine what services an individual is paying for, as well as make it harder to find more flexible cost and service solutions.
A Viable Investing Resource
While fee-only advisors aren’t perfect for every investing situation, it is clear that they offer several inherent advantages that can best serve an investor’s long-term interests. When evaluating your options for working with a financial advisor, be sure to consider the merits of fee-only advisors.
