I have worked in many different areas of finance and investing. I spent time in corporate finance at a small local investment banking company, I worked for one of the largest local hedge funds in Minnesota, and almost ended up on the Edward Jones career path. But thankfully I ended up working for a small private wealth management company that billed themselves out as fee-only. This was a new concept to me at the time as I had always thought of Edwards Jones and other broker/dealers (explained later) as the only way to do Expat financial advice Singapore. My eyes were opened and led me down the path of starting my own fee-only financial planning firm. My hope in this article is to explain the various ways a financial advisor is paid and why this is critical to your success with your investments and retirement.
Traditional Financial Advisors
First let’s start off with “traditional” financial planners. The primary way in which they are paid is through commissions. A commission based advisor is paid by insurance companies and mutual fund companies when they sell those companies products. You, the client, never pay anything directly to the advisor which is why these types of advisors sometimes sell their services as “free”. This is far from the truth. Even though you are not paying the advisor directly you are paying the investment companies that the advisor is representing. This comes in the form of sales-charges (loads), various commissions, and ongoing management expenses as well as bonuses like paid travel. Because of this advisor is no longer independent and third parties, the financial companies, are now the ones paying the advisor. These commission based advisors are also known as “broker/dealers.” These broker/dealers are really just financial salesmen because their goal is to sell you products which in turn provide them with their commissions. Are you starting to see the problem with this arrangement? The issue isn’t that the advisor is paid; the problem is that it creates a conflict of interest between the client and the advisor. The commissions provide an incentive to sell products with the highest payout to the advisor regardless of whether or not this is in the best option for the client. This is why you see a lot of unnecessary products like loaded mutual funds (A, B, C share classes), permanent/whole life policies, and annuities, all of which are very expensive.
Fee-Only Financial Advisors
What I found out from my work experience is that there is a better way to provide financial advice. This is where fee-only comes into play. Fee-only financial advisors charge their clients directly for the advice and the on-going management of their assets. This fee is usually a set percentage of the assets they manage for you. The fees are transparent unlike that of the broker/dealers whose charges are often hidden and not thoroughly disclosed. Fee-only advisors receive no other financial reward from any other source besides there stated fee. This means they are not incentivized to push one company’s product over another. They advise on the best investment for your situation so the investments are going to be lower cost and specific to you and your needs. They rely more on education rather than various sales techniques to gain clients. This compensation structure aligns the goals of the advisor with yours, which is to grow your wealth.
The Fiduciary Standard
Fee-only financial planners are registered with the either SEC (Securities and Exchange Commission) or the state in which they operate. They are officially labeled a Registered Investment Advisor or RIA. The law requires that RIAs be held to a Fiduciary Standard. This requires the advisor to act solely in the best interest of the client at all times. They are also required to disclose any conflict of interest, adopt a code of ethics, and fully explain how they are compensated.
Unfortunately, only a small percentage of financial planners are RIAs. Most so-called financial advisors like the broker/dealers mentioned above are not held to a fiduciary standard; they are instead, held to a lower suitability standard. This is very important because they are required by law to act in the interest of their employer, and not in your best interest as the client.
Because broker/dealers may not necessarily be acting in your best interest, they are required to add the following disclosure to their client agreements. Below is this disclosure. Read it and then decide if this is the type of relationship you want dictating your financial security:
“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore our profits, and our salespersons’ compensation, mat vary by product and over time.”
If you are already working with an advisor, check for this disclaimer in the advisory agreement. If you find it, you should ask additional questions about how they are compensated. Then decide if this is the right relationship for you.
Fee-Only is Not the Same as Fee-Based
Fee-only planning has gained in popularity in the last few years due to its transparent compensation structure and reduced conflicts of interest. Because of this the broker/dealer world has taken notice. In order to get their share of the market back they have added “fee-based” planning 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. Ergo, the conflicts of interest remain, there is still no fiduciary standard, and there is still an incentive to push unnecessary products. Make no mistake, any sort of indirect compensation creates a conflict of interest and lessens the advisor’s ability to keep the client’s best interests first and foremost.