There exists a simple but undeniable truth in the financial consulting and wealth preparing industry that Wall Street provides kept as a “dirty little secret” for years. That dirty little, plus nearly always overlooked secret is THE WAY YOUR FINANCIAL ADVISOR IS COMPENSATED DIRECTLY AFFECTS THEIR FINANCIAL ADVICE TO YOU!
You want, and deserve (and consequently SHOULD EXPECT) unbiased monetary advice in your best interests. But the fact is 99% of the general investing open public has no idea how their economic advisor is compensated for the tips they provide. This is a tragic oversight, however an all too common one. You can find three basic compensation models with regard to financial advisors – commissions dependent, fee-based, and fee-only.
Commission Dependent Financial Advisor – These experts sell “loaded” or commission paying out products like insurance, annuities, and loaded mutual funds. The commission payment your financial advisor is earning on your transaction may or may not be disclosed for you. I say “transaction” because which 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 already have 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 investment decision products they sell, there is an inherent issue of interest in the financial advice given to you and the commission these financial experts earn. If their income is dependent on transactions and selling insurance plus investment products, THEY HAVE A FINANCIAL INCENTIVE TO SELL YOU WHATEVER PAYS THEM THE HIGHEST COMMISSION! That’s not to say generally there aren’t some honest and ethical commission based advisors, but clearly this identifies a conflict appealing.
Fee Based Financial Advisor – Below is the real “dirty little secret” Walls Street doesn’t want you to know about.
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Wall Street (meaning the companies and organizations involved in buying, marketing, or managing assets, insurance and investments) has sufficiently blurred the lines between the three ways your financial advisor may be compensated that 99% of the investing public feels that hiring a Fee-Based Financial Advisor 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 indicates is that your financial advisor can take costs AND commissions from selling insurance plan and investment products! So a “base” of their compensation may be associated with a percentage of the assets they manage on your behalf, then the “icing on the cake” is the commission income they can potentially earn by selling you percentage driven investment and insurance items.
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 best and unbiased way to get monetary advice is through a FEE-ONLY monetary advisor. I stress the word “ONLY”, because a truly fee ONLY financial advisor CAN NOT, and WILL NOT take commissions in any form. A Fee-ONLY financial advisor earns FEES by means of hourly compensation, project financial planning, or a percentage of assets handled on your behalf.
All fees are in monochrome, there are no hidden forms of compensation! Fee-Only financial advisors believe in FULL DISCLOSURE of any potential clashes of interest in their compensation and the financial advice and guidance provided for you.
Understanding the conflict of interest in the monetary advice given by commission based agents enables you to clearly identify the issue of interest for fee-based financial advisors also – they earn fees AND commissions! Hence – FEE-BASED MEANS NOTHING! There is only one correct way to get the most unbiased, honest and ethical advice possible and that is through a financial advisor who believes in, and practices, full disclosure.
Percentage and Fee-Based financial advisors generally don’t believe in or practice full-disclosure, because the sheer magnitude of the the fees the average investor/consumer pays would certainly surely make them think twice.
Consider for a moment you need to buy a truck especially for towing and hauling heavy tons. You go to the local Ford dealership and talk to a salesperson – that salesperson asks what type of vehicle you’re interested in and shows you their line of trucks. Of course , to that salesperson who makes a commission when you buy a truck – 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 makes great trucks, GM makes great trucks, Dodge makes great vehicles. The Ford may or may not be the best pickup truck for your needs, but the salesperson ONLY shows you the Ford, because that’s All of the salesperson can sell you and create a commission from.
This is similar to the commission based financial advisor. When they sell annuities, they’ll show you annuities. If they sell mutual funds, most they’ll show you is commission paying out mutual funds. If they sell life insurance, they’ll tell you life insurance is the way to all of your financial problems. The fact is, when all you have is a hammer… everything looks like a nail!
Now consider for a moment you hired a car buying advisor and paid them a flat fee. That advisor is an professional and stays current on all the new vehicles. That advisor’s only incentive is to find you the most suitable truck for you, the one that hauls one of the most, tows the best, and is clearly your best option available. They earn a charge for their service, so they want you to be happy and refer your family and friends to them. They even have special plans worked out with all of the local car dealerships 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 analogy of a “car buying advisor” is similar to a Fee-Only financial planner. Fee-Only financial advisor’s use the best offered investments with the lowest possible price. A Fee-Only financial advisor’s just incentive is to keep you happy, to earn your trust, to provide the best possible financial advice and guidance using the most appropriate investment tools and preparing practices.
So on one hand you have a car salesperson who’s going to earn the commission (coincidentally the more you buy the truck the more they earn! ) to sell you one of the trucks off their lot. On the other hand, you do have a trusted car buying advisor who else shops all of the vehicles to find the most appropriate one for your specific needs, and because of his relationships with all of the car dealers can also get you the best possible cost 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 aren’t paying and what you’re getting in come back for the compensation your Fee-Only monetary advisor earns. Everything is in black and white, and there are no hidden agenda’s or conflicts of interest in the assistance given to you by a true Fee-Only financial advisor!
The fact is unfortunately lower than 1% of all financial advisor professionals are truly FEE-ONLY. The reason for this? There’s a clear and substantial disparity in a financial advisor’s income produced through commissions (or commissions and fees), and the income a financial advisor makes through the Fee-Only model:
Example #1 – You just changed employment and you’re rolling over a $250, 000 401k into an IRA. The particular commission based advisor may market you a variable annuity in your IRA (which is a very poor planning strategy in most cases and for many reasons) plus earn a 5% (or often more) commission ($12, 500) and get an ongoing, or “trailer” commission associated with 1% (plus or minus) corresponding 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 the portfolio to manage it. Let’s say in this instance you pay a $500 retirement plan fee and 1 . 25% of assets managed (very common for a Fee-Only financial advisor on this situation). That advisor earns $250 plus $3, 125 ($250, 000 * 1 . 25%) or COMPLETE COMPENSATION of $3, 625 — FAR LESS THAN THE $15, 000 THE PARTICULAR COMMISSION (or Fee-Based) financial consultant earned! In fact it takes the Fee-Only financial advisor over four yrs to earn what the commission (or fee-based) advisor earned in one calendar year!
Example #2 – You’re upon the market and managing a $750, 000 nest egg which needs to provide you revenue for the rest of your life. A fee-based economic advisor may recommend putting $400, 000 into an single high quality immediate annuity to get you income and the other $350, 000 into a fee-based managed mutual fund platform. The annuity may pay a payment of 4% or $16, 1000 and the fee-based managed mutual finance portfolio may cost 1 . 25% for total compensation of $20, 375 first year (not including the “trailer” commissions). The Fee-Only consultant would possibly shop low load annuities for you, possibly put the entire profile into a managed account, possibly look at municipal bonds, or any other variety of options available. It’s hard to say just how much the Fee-Only advisor would earn as their largest incentive is to a person the client happy, and provide the best planning advice and guidance possible for your circumstances. BUT , in this case let’s just imagine a managed mutual fund profile was implemented with an averaged cost of 1% (very common for that degree of assets), so the Fee-Only financial advisor earns roughly $7, 500 per year and it takes that financial advisor THREE YEARS to earn what the fee-based financial advisor earned in ONE YEAR!
The prior examples are very common in today’s financial advisory industry. It’s regrettable that such a disparity in earnings exists between the compensation models, or there would likely be many more really independent and unbiased Fee-Only economic advisors today!
Now consider for any moment which financial advisor works harder for you AFTER the initial consultations an planning? Which financial consultant must consistently earn your rely on and add value to your monetary and investment planning? It’s obvious the financial advisor with the most to get rid of 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 lose. You can fire them after they already have put you in their high commission rate 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 and investment planning, and little to lose by losing you as a customer.