How is my Financial Advisor Compensated? – Fee-Only vs. Fee-Based

Over the years, I have encountered a great deal of confusion among the public surrounding Fee-Based vs. Fee-Only advisor compensation.

Fee-Only is pretty straightforward. The client pays the advisor for his/her advice. The fees can take one or more of several forms:

• A flat fee for the services rendered.
• A percentage of the client’s investment assets or in some cases another metric such as net worth.
• Hourly

Additionally the fee can be for one-time or ongoing services. In no case will a Fee-Only advisor receive any compensation from sales commissions, trailing commissions, or any other form of compensation derived from financial product providers.

Fee-Based compensation is bit fuzzier and quite often very misunderstood by the public. A typical Fee-Based arrangement might work like this:

The advisor will charge a set fee for the initial financial plan. This is the “fee” part of the arrangement. However, in many cases, if the client wants to implement the advisor’s recommendations for investments, insurance, and other financial products this will be done via the sale of commissioned products.

Where Fee-Based can become even more confusing is in the case of a broker or registered rep using a wrap program as a means to implement investment recommendations. A wrap involves investment management services for a percentage of the assets under advisement, a structure similar to that used by many Fee-Only advisors.

What differs in most cases is that the Fee-Based advisor and their broker-dealer will also receive compensation from the underlying investment vehicles (mutual funds, etc.) in the form of 12b-1 fees or a similar form of trailing fee, or in the form of commissions on stock trades executed exclusively through the advisor's brokerage firm. Additionally it has been my experience that often the assets under management fee for these wrap programs is higher that charged by most Fee-Only advisors for similar asset levels.

I am a Fee-Only advisor and am admittedly biased. My point in writing this post was not to disparage those advisors who are not Fee-Only, although I do remain convinced that this is the most client-friendly compensation structure. Rather, I want to reiterate that clients and those looking for a financial advisor need to understand what they are paying for, how much they will be paying, and how they will be paying for financial advice and any financial or investment products they will be purchasing.

For more please see my prior posts:

"How is my Financial Compensated?" http://ow.ly/Gmcc

"Why Should I Care if My Financial Advisor is a Fiduciary?" http://ow.ly/GmcQ

The idea for this post originally came from a recent post and some of the subsequent comments on the Oblivious Investor Blog:

"How Much Does a Financial Advisor Cost?" http://ow.ly/Gmfm

Wondering where you can find the names of Fee-Only financial advisors in your area? Check out NAPFA’s website http://napfa.org/ and click on the Find An Advisor button on the left side of the site. (Full disclosure, I am a member of NAPFA and also a member of the organization’s Midwest Regional Board.)