Fee-Only Versus Fee-Based – Conflicts Of Interest And The Fiduciary Standard
Financial planners can be paid in multiple ways, hourly fees, on-going management fees, or through commissions earned by selling products. Fee-only planning has gained in popularity in the last few years because of its transparent compensation structure and because it removes the conflict of interest associated with selling a commission based product. This means more clients are switching to these types of planners. In response, many commission based advisors have attempted to get their share of the market back by offering fee-based planning in addition their commission based practice.
So let’s take a look at what “Fee-Only” financial planners are and why it is so important. First off, they are never paid a commission. An advisor compensated through commissions inherently faces a conflict of interest between the interests of the client and that of the financial professional. These commissions provide an incentive to sell products with the highest payout to the advisor (e.g. loaded mutual funds, variable annuities, whole life insurance) regardless of whether or not this is the best option for the client. “Fee-only” advisors are paid based on a percentage of the assets they manage. This aligns the planner’s goals with those of the client, which is to grow a client’s wealth. But the real difference comes from the Fiduciary Standard. Fee-only financial registered investment advisors are held to this standard, which means by law, they must have their clients’ best interest at heart. Therefore, fee-only planners will recommend the best investments for a client not the ones with the highest payout.
Because of the obvious popularity of this model, commission based advisors have started adding “Fee-Based” as an option to their clients. Do not be confused. This means that some of their compensation comes directly from their clients as fees, but not all. They still sell financial products to their clients for commissions or accept referral fees to refer their clients to other professionals.
With these conflicts of interest in place a financial plan becomes just another “sales pitch”. After analyzing a person’s cash flows an advisor will “show” the client how they need more insurance, which they can conveniently sell to them.
Also, an advisor who earns commissions by selling products has the incentive to sell more products. Therefore, if the advisor has to meet their sales goals for the month, all they need to do is come up with a reason to sell one fund and then purchase a new one generating more commissions. This does not mean that all commission based advisors would act in this manner, but the conflict of interest and incentives are still present.
For more information about Fee-Only planning check out NAPFA.org. They are the best resource for Fee-Only planning and the Fiduciary Standard.