There is 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, and nearly always overlooked secret is THE METHOD YOUR FINANCIAL ADVISOR IS COMPENSATED DIRECTLY AFFECTS THEIR FINANCIAL ADVICE TO YOU!
You want, and deserve (and consequently SHOULD EXPECT) unbiased financial advice in your best interests. But the fact is 99% of the general investing public has no idea how their financial 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 intended for financial advisors – commissions centered, fee-based, and fee-only.
Commission Centered Financial Advisor – These experts sell “loaded” or commission paying products like insurance, annuities, plus loaded mutual funds. The percentage your financial advisor is gaining on your transaction may or may not be disclosed to you. I say “transaction” because gowns what commission based financial advisors do – they facilitate TRANSACTIONS. Once the transaction is over, you may be lucky to hear from them again because they’ve already earned the bulk of whatever commission rate they were going to earn.
Since these types of advisors are paid commissions which may or may not be disclosed, and the quantities may vary based on the insurance and expenditure products they sell, there is an inherent issue of interest in the financial advice provided to you and the commission these financial advisors earn. If their income is dependent on transactions and selling insurance plus investment products, THEY HAVE A FINANCIAL INCENTIVE TO SELL YOU WHATEVER PAYS ALL OF THEM THE HIGHEST COMMISSION! That’s not to say right now there aren’t some honest and ethical commission based advisors, but clearly this identifies a conflict of interest.
Fee Based Financial Advisor – Here’s the real “dirty little secret” Wall Street doesn’t want you to learn about. Wall Street (meaning the companies and organizations involved in buying, marketing, or managing assets, insurance plus investments) has sufficiently blurred the lines between the three ways your own financial advisor may be compensated that will 99% of the investing public believes that hiring a Fee-Based Financial Consultant is directly correlated with “honest, ethical and unbiased” financial advice.
The fact is FEE-BASED MEANS NOTHING! Think about it (you’ll understand more when you learn the third type of compensation), all fee-BASED means is that your financial advisor can take charges AND commissions from selling insurance and investment products! So a “base” of their compensation may be tied to a percentage of the assets they manage on your behalf, then the “icing on the cake” is the commission income they can possibly earn by selling you percentage driven investment and insurance products.
Neat little marketing trick right? Lead off with the word “Fee” so the general public thinks the payment model is akin to the likes of attorney’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 most appropriate and unbiased way to get economic advice is through a FEE-ONLY monetary advisor. I stress the word “ONLY”, because a truly fee ONLY economic advisor CAN NOT, and WILL NOT accept commissions in any form. A Fee-ONLY financial advisor earns FEES in the form of hourly compensation, project financial planning, or a percentage of assets managed on your behalf.
All fees are in black and white, there are no hidden forms of compensation! Fee-Only financial advisors believe in FULL DISCLOSURE of any potential conflicts of interest in their compensation and the financial advice and guidance provided to you.
Understanding the conflict of interest in the monetary advice given by commission based agents enables you to clearly identify the discord of interest for fee-based financial advisors also – they earn fees AND commissions! Hence – FEE-BASED MEANS NOTHING! There is only one genuine way to get the most unbiased, honest plus ethical advice possible and that is through a financial advisor who believes in, and practices, full disclosure.
Commission rate and Fee-Based financial advisors typically don’t believe in or practice full-disclosure, because the sheer magnitude of the the fees the average investor/consumer pays might surely make them think twice.
Consider for the moment you need to buy a truck especially for towing and hauling heavy a lot. You go to the local Ford dealership plus talk to a salesperson – that salesperson asks what type of vehicle you have in mind and shows you their line of vehicles. Of course , to that salesperson who earns a commission when you buy a vehicle – ONLY FORD has the correct truck for you. It’s the best, it’s the only way to go, and if you don’t buy that truck from that salesperson you’re crazy!
The fact is Toyota can make great trucks, GM makes excellent trucks, Dodge makes great trucks. The Ford may or may not be the best vehicle 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 a commission based financial advisor. When they sell annuities, they’ll show you annuities. If they sell mutual funds, just about all they’ll show you is commission having to pay mutual funds. If they sell insurance coverage, they’ll tell you life insurance is the means to fix all of your financial problems. The fact is, when all you have is a hammer… everything appears to be a nail!
Now consider for any moment you hired a car buying advisor and paid them a flat fee. That advisor is an professional and stays current on all of 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 the 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 dealers to get you the best price on the truck that’s right for you because they want to add value to your relationship with them.
The example of a “car buying advisor” is similar to a Fee-Only financial planner. Fee-Only financial advisor’s use the best obtainable investments with the lowest possible cost. A Fee-Only financial advisor’s just incentive is to keep you happy, in order to earn your trust, to provide the best financial advice and guidance using the most appropriate investment tools and planning practices.
So on one hand you have a vehicle salesperson who’s going to earn the commission (coincidentally the more you spend on the truck the more they gain! ) to sell you one of the vehicles off their lot. On the other hand, there is a trusted car buying advisor who also shops all of the vehicles to find the most suitable one for your specific needs, and then because of his relationships with all of the vehicle 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 if you’re paying and what you’re getting in return for the compensation your Fee-Only economic advisor earns. Everything is in monochrome, and there are no hidden agenda’s or conflicts of interest in the suggestions given to you by a true Fee-Only financial advisor!
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The fact is unfortunately lower than 1% of all financial advisor experts are truly FEE-ONLY. The reason for this particular? There’s a clear and substantial difference in a financial advisor’s income created through commissions (or commissions and fees), and the income a financial advisor earns through the Fee-Only model:
Example #1 – You just changed employment and you’re rolling over a $250, 1000 401k into an IRA. The particular commission based advisor may sell you a variable annuity in your IRA (which is a very poor planning approach in most cases and for many reasons) plus earn a 5% (or many times more) commission ($12, 500) and obtain 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 your portfolio to manage it. Let’s say in cases like this you pay a $500 pension plan fee and 1 . 25% of assets managed (very typical for a Fee-Only financial advisor on this situation). That advisor earns $250 plus $3, 125 ($250, 1000 * 1 . 25%) or TOTAL COMPENSATION of $3, 625 — FAR LESS THAN THE $15, 000 THE PARTICULAR COMMISSION (or Fee-Based) financial advisor earned! In fact it takes the Fee-Only financial advisor over four years to earn what the commission (or fee-based) advisor earned in one yr!
Example #2 – You’re outdated and managing a $750, 000 nest egg which needs to provide you revenue for the rest of your life. A fee-based monetary advisor may recommend putting $400, 000 into an single superior immediate annuity to get you income and the other $350, 000 into a fee-based managed mutual fund platform. The annuity may pay a commission of 4% or $16, 500 and the fee-based managed mutual account portfolio may cost 1 . 25% for total compensation of 20 dollars, 375 first year (not including the “trailer” commissions). The Fee-Only advisor would possibly shop low load annuities for you, possibly put the entire profile into a managed account, possibly take a look at municipal bonds, or any other selection of options available. It’s hard to say just how much the Fee-Only advisor would generate as their largest incentive is to keep you the client happy, and provide the best planning advice and guidance possible for your situation. BUT , in this case let’s just imagine a managed mutual fund portfolio was implemented with an averaged price of 1% (very common for that amount of assets), so the Fee-Only financial consultant earns roughly $7, 500 per year and it takes that financial consultant THREE YEARS to earn what the fee-based financial advisor earned in ONE CALENDAR YEAR!
The prior examples are very common in the current financial advisory industry. It’s unlucky that such a disparity in income exists between the compensation models, or there would likely be many more truly 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 believe in and add value to your financial 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 lack of income on a regular basis from losing a customer.
The commission or fee-based financial advisor however has little to reduce. You can fire them after they already have put you in their high commission payment products, and as you can see from the good examples they’ve already made the majority of the income they’re going to make on you as a client. They have little to gain by ongoing to add value to your financial plus investment planning, and little to lose by losing you as a customer.