Several important considerations favor using fee-only financial advisors over advisors and investment counselors who accept third party commissions and other payments.
Fee-only payment arrangements with advisors allow clients to: 1) maintain trust and reduce unethical behavior, 2) separate financial decisions from purchases, and 3) obtain lower cost financial products. Percent of asset fees align client and advisor interests. Hourly fees and fixed fees unrelated to amount of assets can be even better from the standpoint of the client, when the advisor is competent and the advice is focused on the best interests of the client. With hourly and fixed fees that client knows what he or she is paying and keeps the full benefit of the advice.
Fee-only compensation arrangements allow individuals to maintain trust more easily. The client and advisor relationship should be based upon a bedrock of trust. Investors prefer never to feel the need to question the motivations behind any particular financial recommendation made to them. As in any other professional relationship, an investor wants to have absolute confidence in the competence, objectivity, ethics, and goodwill of his financial advisor.
When you engage a doctor for medical services, you do not want to worry continually about whether your doctor is competent and ethical or whether your medical interests will be sold out to the higher bidder?
In the practice of medicine, the lines of demarcation regarding ethical behavior and patient’s interests seem much clearer than in investing. Doctors have an ethical tradition dating back at least to Hippocrates that has been honored by each new generation of doctors. (Recently, of course, escalating costs and managed care have intervened to place some ethical stress on the doctor-patient relationship. Interestingly, financial interests are at the heart of this conflict of interest in a doctor/patient relationship.)
As with the doctor-patient relationship, you want your financial advisor to put your interests on top. This often is difficult when money is involved. Except for the comfortably rich, whose means far exceed their desires, everyone else, including financial and investment advisors, feel financial pressures. Their kids need braces… a vacation would be nice… that sportster would be fun to drive…
When you want the best financial plan and personal investment strategy that you can get for you family, do you really want to have to worry about your financial advisor’s ethics?
Do you want to wonder whether he is glibly spouting well-crafted sales messages, while he loads up your portfolio with high commission financial products to pay for his car, his vacation, and his kid’s braces and not yours?
Fee-only advisors can better separate financial decision-making from the purchase of financial products. This helps to assure that the decision process is unbiased and that better financial products can be found for the client. Fee-only advisors can more objectively determine which particular financial products will better meet their clients’ needs.
Firms in the financial services industry compete for the business of individuals and their financial advisors using different distribution strategies.
All financial services firms face challenges in finding efficient ways to advertise, market, and sell their products to advisors and individual investors. The net cost to an individual to acquire a particular kind of financial product with the same intrinsic value as another can vary dramatically due to these distribution issues.
To earn their compensation, objective and competent fee-only advisors will find better, more cost-effective options for their clients. Often the most advantageous products for individuals are those that do not bear substantial up front and recurring distribution channel costs. There will always be an associated distribution channel cost to pay your commissioned advisor.
Investors who use commissioned advisor are far more likely to acquire financial and investment products with higher distribution costs. Commissioned advisors will claim that their products are better, but such claims lack a factual basis. The scientific investment literature consistently has demonstrated that higher distribution costs mean lower returns for investors.
Saving on distribution channel costs is just one way very important way that a fee-only financial advisor can save money for clients.
In addition to the high distribution channel cost, commissioned products may not necessarily be the best available from the point-of-view of the client. Fee-only advisors can identify the best products from across the industry. They are not restricted only to those that pay commissions.
Like ancient maps of the unknown seas, navigating the sea of advisor self-interest requires us to put the label “Here There Be Dragons” on some parts of the advisory map. The simplest way for an individual to avoid conflict-of-interest problems is to employ a fee-only advisor, after also assuring that he or she is competent, hard working, and reasonably priced.
See these related articles on advisor compensation:
Tags: practice of medicine
Personal Financial Planning
- Objective Personal Finance Answers Are Hard to Find (The Problem - Straight answers about personal financial planning and investment management are difficult to find
In this article, The Skilled Investor summarizes some of the significant problems faced by ordinary individuals, when they attempt to plan their family finances. This is the first in a series of articles that will provide scientifically grounded decision rules [...])
- Part 3 of the Never-Do List – What Not to Do with a Financial Advisor (
Part 3 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should "never do" with a financial planner or investment advisor, and it covers unsolicited advice, sales pressure, and account decision-making discretion.
You should never do certain things with a financial [...])
- The Economics of the Financial Investment Advisory Industry (Everyone has similar, yet distinct, financial planning needs regarding their families' financial futures.
While more wealthy people (think millions of dollars) have greater complexity to their financial affairs (caused largely by our incredibly convoluted U.S. personal tax codes), everyone needs sophisticated financial lifecycle planning. Whether wealthy or not yet wealthy, families need a personalized way to [...])
- Financial Planner and Investment Advisor Compensation Paid by Third Parties (There are three primary types of third party or commission-based compensation: commission-only, fee-based commission, and fee-offset commission.
How an advisor is compensated can be a very important issue. With commission-only advisors, there is no direct cost to the client for planning and advice. The advice appears to be free, but it is not. Most clients find [...])
- The most effective strategy to increase your mutual fund and ETF investment returns (
What is the most effective strategy you have to increase your long-term mutual fund and ETF investment returns?
Just reduce your investment fees to rock bottom and buy directly to eliminate all sales loads. This strategy is both simple and entirely within your control. You do not have to be smarter than all those other smart [...])
- Choose objective and competent financial advisers and investment counselors – Step 10 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
Pick financial and investment advisers solely to obtain objective and high quality advice. Specific financial and investment advice is potentially of high quality, if it is carefully customized to your particular needs and is given by an [...])
- The Kind of Financial Advisor You Need (
The kind of financial advisor you need - A Tip from The Skilled Investor
Good or bad, financial advisors are expensive. If you need a financial advisor's help and you carefully select a good financial advisor, the value of the personal finance and investment advice that you receive might easily repay the advisor cost. However, bad [...])
- Does it matter how financial planners and investment advisors are paid? (
Yes, it can matter significantly how a financial advisor is paid.
The heart of the compensation issue is an advisor’s potential "conflict of interest" with respect to payments from third parties. Does third party compensation change the quality of the recommendations that the advisers make? If an advisor works on sales commissions or accepts other third [...])
- The Never Do List – Avoid Financial Advisor Frauds and Scams (
Part 2 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should “never do” with a financial planner or investment advisor, and it covers fees, payments, and proprietary investments.
You should never do certain things with a financial planning or investment [...])
- Avoiding Financial Advisor Frauds and Scams – Part 1 (
Part 1 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should “never do” with a financial planner or investment advisor, and it covers adviser selection, contracts, signatures, and ownership title of your assets.
You should never do certain things with [...])
- The Investment Returns You Lose to Investment Sales Loads (VeriPlan automatically tracks returns lost to investment sales loads
Many justifications for investment sales load charges might be offered by financial advisors during the sales process, but once a front-end load is charged, your diminished portfolio will 'forget' about the load charge for the rest of your life.
Loads become 'phantom' assets, which are rarely spoken of [...])
- Financial Industry Product Development and Your Best Interests (
Financial research drives industry product development, but not necessarily toward the best interests of individuals
Personal financial decisions seem to have become very complicated. To add to the confusion, the financial services industry develops an unending array of supposedly innovative new products. However, a large part of the complexity that individuals face results from the proliferation [...])
- Advisor Costs and Strategies Determine Your Return on their Services (Financial advisor costs and the value of their investment strategies determine your return on investment from these investment advisor services
A previous financial article, “The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that investors are much better off with a well-considered financial [...])
- Financial Advisor and Investment Counselor Compensation Paid by Clients (There are three primary types of client paid advisor compensation: hourly-fee, fixed-fee, and asset-fee.
When choosing an advisor, individuals should first decide the type of advisor compensation that makes them most comfortable. How an advisor is compensated can be a very important issue. When you hire a financial planner or investment advisor, 1) you pay directly [...])
- 22 Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams (Avoiding financial advisor and investment counselor frauds and scams - Overview
The best way to avoid being defrauded or scammed by a financial or investment advisor is to investigate carefully several different advisers before hiring one of them.
If you carefully choose a financial adviser or investment counselor, you have a far greater chance of finding one [...])