When selecting a Financial Advisor, there are many factors you should take into account. These factors include the advisor’s educational background, professional designations, experience and references. One of the most important considerations when choosing an advisor is how the advisor is compensated for his or her services.
Advisors and their firms can be compensated in myriad ways. The following is a brief description of some of the most common advisory compensation schemes:
- Fee-Only: Clients are charged an hourly rate, flat fee, or asset management fee for comprehensive financial services. Fee-Only Advisors never collect commissions or referral fees paid by other product or service providers.
- Commission Only: The advisor charges a commission on transactions and/or securities, insurance, and other products that a client purchases through the Advisor’s firm.
- Fee and Commissions: Also known as “fee-based,” the advisor charges a fee (as defined above for Fee-Only) on some products and services, and also collects a commission on other transactions and products.
Fee-Only Advisory relationships can provide significant benefits to the client compared to the other common compensation models. One of the benefits of Fee-Only advice is that it often results in lower out-of-pocket expenses for the client. Fee-Only Advisors use only no-load and low-load products as well as a host of discounted services. In contrast, advisors who are not Fee-Only often utilize products that have significant upfront sales loads (sometimes to the tune of 5% or more) as well as annual and deferred sales charges.
Another issue with commission-based advisors is that many of the charges a client pays are fairly well hidden. It’s not unusual for a client to be paying much more in sales and related charges than they realize they are paying because much of the overall cost is hidden in fine print.
Perhaps the most important benefit from working with a Fee-Only Advisor is objectivity. When an advisor charges a commission for products or services, a conflict of interest is introduced into the relationship. That conflict may impact the quality of advice that the client receives. In contrast, the Fee-Only Advisor is able to choose from a host of products and services and choose the ones that are best for the client, without regard to personal gain that may come from making a certain recommendation. The Fee-Only Advisor is not beholden to insurance companies, particular investments, or other financial companies.
The following are some examples of conflicts of interest introduced by the commission model of advisor compensation:
A commissioned advisor might be incentivized to advise a client to make investments so that the advisor may collect a commission, when in actuality holding cash may be a more suitable recommendation at the time.
A commissioned advisor may be tempted to unnecessarily buy and sell securities (known as “churning”) to generate commissions.
A commissioned advisor might be motivated to recommend that a client convert non-cash assets such as real estate and collectibles to cash that can be reinvested so that the advisor can collect commissions.
A commissioned advisor may be tempted to make recommendations that pay higher commissions when a less expensive and/or more suitable alternative is available.
In conclusion, clients should strongly consider a firm’s method of collecting compensation for its products and services when choosing a Financial Advisor. Fee-Only compensations schemes often result in lower out-of-pocket costs for clients, as well as more objective advice. Here at JoycePayne Partners we are proud of our Fee-Only structure, and we are happy to be able to focus fully on what is best for each and every client.