The financial press has in large part touted the merits of working with a financial advisor who is compensated only by the fees he or she charges directly to clients and not via the sale of financial products. To be clear on terms, an advisor who is compensated only by fees is fee-only. These fees might be hourly, a flat retainer or be based on a percentage of your investment assets.
Fee-based or fee and commission advisors generally are compensated via both fees for advice and commissions on the sale of financial products that may be used to implement their advice. Commissioned advisors are paid solely by the commissions earned from selling various financial and insurance products.
Pros of Using a Fee-only Advisor
One of the major benefits of selecting a fee-only advisor is a freedom from the inherent conflict of interest that can arise when a significant portion of the advisor’s income comes from selling financial products. The concern you should have as a potential client is whether or not the advisor is recommending a certain financial product because it enhances his/her bottom line and if the products recommended are truly in your best interest. Related to this: In some cases some registered reps and others who earn all or part of their compensation via commission may be required to favor products offered by their employer. These products may or may not be the best vehicles for your situation.
Another benefit of using fee-only financial advisors is the opportunity for them to offer an objective second opinion of your situation. This is especially true if the advisor works with clients on an hourly, as-needed basis or perhaps will do a financial plan or financial review for a fixed project fee. Services here can range from addressing a specific financial question to a review of your investment portfolio to a full-blown financial plan.
Cons of Using a Fee-only Advisor
While I am admittedly biased towards fee-only financial advisors, I don’t really see any cons as such. However, a fee-only advisor is not the right solution for everyone and fee-only advisors are hardly perfect. I do want to point out some of the things investors should be on the lookout for when hiring a fee-only advisor, or any financial advisor for that matter.
No form of advisor compensation is totally conflict-free. If you’re working with an advisor who is compensated via a percentage of the investment assets under management can you always be sure that his or her advice is not tilted towards keeping as much of your money under advisement as possible? For example, if you were to ask about withdrawing say $200,000 from your investment accounts to pay off your mortgage can you be sure the advisor’s advice against doing this wasn’t somehow motivated by the potential lost revenue?
Another issue to consider is that a desirable compensation structure like fee-only does not ensure that the advisor is competent. Just like any other professional, such as a lawyer or an accountant, the knowledge and experience of fee-only financial advisors will vary. Some advisors simply are more knowledgeable than others. Additionally some advisors may be better suited to working with clients with your unique needs than others. For example a fee-only advisor who specializes in working with teachers and government employees nearing retirement probably would not be the best advisor for a high-earning 30-something professional in the private sector.
Some fee-only advisors may only deal with clients with a minimum level of assets to invest, or charge a minimum fee that equates to that asset level. This may exclude a number of investors with smaller portfolios who need advice. You will want to understand issues like this in doing your search for a fee-only advisor.
How to Find a Fee-only Advisor
The National Association of Personal Financial Advisors (NAPFA) is the largest professional organization of fee-only financial advisors in the country. It has a find an advisor link on its website. You can search by zip code and then further by area of specialization. Note that NAPFA members run the gamut from solo practitioners to larger multi-advisor firms. Additionally, NAPFA members offer a wide range of service options including hourly as-needed services, ongoing investment and portfolio advice, and almost everything in between. Here is a link to an excellent guide to selecting an advisor that NAPFA offers.
The Garrett Planning Network is another organization of fee-only financial planners who mostly focus on providing hourly advice. There is a degree of overlap in the membership of the Garrett Planning Network and NAPFA. It also has a find an advisor function.
The accounting profession also has a financial planning designation for CPAs called the PFS (Personal Financial Specialist). Please note that while many holders of the PFS designation are fee-only this is not a requirement. You will need to ask these folks how they are compensated; here is a link to find a local PFS holder.
The CFP Board also has a directory of financial advisors who hold the CFP designation. Again, being a CFP does not mean the advisor is fee only. The CFP Board recently has revised its compensation classifications to include fee-only, fee and commission, and commission. There has been some controversy surrounding its definition of fee-only so again investors using this database need to ask and be diligent in investigating advisors found here to ensure they are fee-only. Here is a link to the CFP Board’s find a financial planner section of their site.
The Bottom Line
Choosing a financial advisor to help your with your unique financial needs is not an easy task. You will want to look at a prospective advisor’s experience, education and training, and you will want to understand the types of clients he or she generally works with. Additionally, you will want to understand how the advisor would be compensated for working with you. Compensation arising from sales commissions on financial products could cause advisors to recommend products mandated by their employer and/or products generating the highest commissions for the advisor. These products might not always be the best fit for your situation even if they meet the standard of suitability. While fees for advice are more visible, commissions may be harder to ascertain. Make no mistake, the commissions paid to a financial advisor come out of your pocket in the form of higher expenses and lower returns. Fee-only is not a perfect arrangement, but it is generally a bit more transparent and might be a good fit for you.