There is a simple but undeniable truth in the financial consulting and wealth planning industry that Wall Street offers 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 SUGGESTIONS 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 community has no idea how their financial advisor is compensated for the suggestions they provide. This is a tragic oversight, yet an all too common one. You can find three basic compensation models for financial advisors – commissions centered, fee-based, and fee-only.
Commission Centered Financial Advisor – These advisors sell “loaded” or commission having to pay products like insurance, annuities, and loaded mutual funds. The percentage your financial advisor is gaining on your transaction may or may not be disclosed for you. I say “transaction” because that’s what commission based financial experts do – they facilitate DEALINGS. Once the transaction is over, you may be fortunate to hear from them again because they are yet to already earned the bulk of whatever commission payment 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 investment products they sell, there is an inherent discord of interest in the financial advice given to you and the commission these financial experts earn. If their income is dependent upon 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 there aren’t some honest and honest commission based advisors, but obviously this identifies a conflict appealing.
Fee Based Financial Advisor – Here is the real “dirty little secret” Wall Street doesn’t want you to know about. Wall Street (meaning the firms and organizations involved in buying, selling, or managing assets, insurance plus investments) has sufficiently blurred the lines between the three ways your financial advisor may be compensated that will 99% of the investing public thinks that hiring a Fee-Based Financial Advisor is directly correlated with “honest, ethical and unbiased” financial advice.
The fact remains FEE-BASED MEANS NOTHING! Think about it (you’ll understand more when you learn the 3rd type of compensation), all fee-BASED means is that your financial advisor can take fees AND commissions from selling insurance coverage and investment products! So the “base” of their compensation may be associated with a percentage of the assets they deal with on your behalf, then the “icing on the cake” is the commission income they can potentially earn by selling you commission driven investment and insurance products.
Neat little marketing trick correct? Lead off with the word “Fee” so the general public thinks the payment 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 financial advice is through a FEE-ONLY economic 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 preparing, 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 COMPLETE DISCLOSURE of any potential conflicts of interest in their compensation and the economic advice and guidance provided to you.
Understanding the conflict of interest in the monetary advice given by commission based brokers enables you to clearly identify the conflict of interest for fee-based financial advisors also – they earn charges AND commissions! Hence – FEE-BASED MEANS NOTHING! There is only one real way to get the most unbiased, honest plus ethical advice possible and that is by way of a financial advisor who believes in, and practices, full disclosure.
Commission and Fee-Based financial advisors usually don’t believe in or practice full-disclosure, because the sheer magnitude of the the particular fees the average investor/consumer pays might surely make them think twice.
Consider for the moment you need to buy a truck specifically 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’re interested in and shows you their line of trucks. Of course , to that salesperson who makes a commission when you buy a vehicle – ONLY FORD has the right truck for you. It’s the best, it is the only way to go, and if you don’t buy 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 the salesperson can sell you and create a commission from.
This is similar to a commission based financial advisor. If they sell annuities, they’ll show you annuities. If they sell mutual funds, most they’ll show you is commission spending mutual funds. If they sell insurance coverage, they’ll tell you life insurance is the treatment for all of your financial problems. The fact is, when all you have is a hammer… everything appears to be a nail!
Now consider to get a moment you hired a car purchasing advisor and paid them a set fee. That advisor is an specialist and stays current on all the new vehicles. That advisor’s just 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 preparations worked out with all of the local car dealers to get you the best price on the truck read that right for you because they want to add value 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 available investments with the lowest possible cost. A Fee-Only financial advisor’s only 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 buy the truck the more they acquire! ) to sell you one of the vehicles off their lot. On the other hand, you do have a trusted car buying advisor which shops all of the vehicles to find the most appropriate one for your specific needs, and because of his relationships with all of the vehicle dealers can also get you the best possible price on that vehicle. Which would you like?
Truly unbiased financial advice and guidance comes in the form of Fee-Only financial planning. You know exactly what you aren’t paying and what you’re getting in return for the compensation your Fee-Only monetary advisor earns. Everything is in monochrome, 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 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 plus fees), and the income a financial advisor earns through the Fee-Only model:
Example #1 – You just changed employment plus you’re rolling over a $250, 500 401k into an IRA. The commission based advisor may sell you a variable annuity in your IRA (which is a very poor planning method 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, an 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 common for a Fee-Only financial advisor in this situation). That advisor earns $500 plus $3, 125 ($250, 500 * 1 . 25%) or TOTAL COMPENSATION of $3, 625 — FAR LESS THAN THE $15, 000 THE 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 year!
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 financial advisor may recommend putting $400, 000 into an single premium immediate annuity to get you income as well as the other $350, 000 into a fee-based managed mutual fund platform. The particular annuity may pay a payment of 4% or $16, 1000 and the fee-based managed mutual fund 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 portfolio into a managed account, possibly look at municipal bonds, or any other selection of options available. It’s hard to say just how much the Fee-Only advisor would earn 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 assume that a managed mutual fund profile was implemented with an averaged price of 1% (very common for that amount 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 SEASON!
The prior examples are very common in the current financial advisory industry. It’s unfortunate that such a disparity in income exists between the compensation models, or even there would likely be many more really independent and unbiased Fee-Only financial advisors today!
Now consider for the moment which financial advisor works harder for you AFTER the initial consultations an planning? Which financial consultant must consistently earn your trust and add value to your economic and investment planning? It’s apparent the financial advisor with the most to shed is the Fee-Only advisor. A Fee-Only financial advisor has a direct lack of income on a regular basis from losing a customer.
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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 products, and as you can see from the good examples they’ve already made the majority of the commissions they’re going to make on you as a customer. They have little to gain by continuing to add value to your financial plus investment planning, and little to get rid of by losing you as a client.