Stockbrokers, Fee-Only Advisors, Fee Based Advisors – What’s the Difference?
by Cathy Pareto, MBA, CFP®
The financial services industry is a very crowded space. With so many “advisors” to choose from, how do you distinguish what type of financial advisor you are working with? How do you know who you can trust with your money? Many financial advisors are nothing more than glorified salespeople with a clever title. The investments they sell have a direct correlation with the compensation they receive. Given those dynamics, what are the odds that you will receive objective advice? Don’t be fooled. The following guide will help you make more informed decisions on how advisors are compensated.
Commission based advice is great—if you’re a broker or brokerage firm. For the investor, however, it’s not always the right solution. This type of advice is plagued with high costs and opaque disclosure—high costs that chip away at your profits. The registered representative (stockbroker) – unlike a registered investment adviser – has no fiduciary duty to place the client’s interests first. Inadequate disclosure coupled with conflicts of interest guarantees that a fair number of people are going to be victimized by bad advice.
Because broker-dealers are not necessarily acting in your best interest, the SEC requires them to add the following disclosure to your client agreement. Read this disclosure, and decide if this is the type of relationship you want to dictate 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, may vary by product and over time.”
If this disclaimer appears in agreements you are signing, you should ask questions of your advisor. Obtain complete disclosure about how he or she is compensated, and where his or her loyalties lie. Then decide if the relationship is in your best interest, running for the exits might be a good option here.
“Fee based” advisors (also referred to as fee-offset) can be just as bad, if not worse. Commission based compensation includes “fee-based” compensation which is a particularly evil label referring to both fees and commissions. Fee based advisors have the ability to charge a percentage “based” on the assets they manage, but they also have the ability to sell you a commission based product (like an annuity, a load fund or life insurance). “Double dipping”, as it’s known in the industry, while not illegal is certainly immoral. The broker makes money from both the client and the commission. What a guy! Don’t be fooled. Stay away from advisors peddling investments that charge you front end or back end loads or surrender charges.
Fee-only compensation (not to be confused with fee-based) is non commission driven and eliminates the exploitation of investors, where quality objective financial advice is the only product, and the advisor sits on the same side of the table with the client. The only way the advisor can make more money on your relationship, is to make more money for you. Federal and state law requires that Registered Investment Advisors are held to a Fiduciary Standard. This law requires that an advisor act solely in the best interest of the client, even if that interest is in conflict with the advisor’s financial interest. This includes finding the best investment alternatives with the lowest internal expenses, and one of the best ways of enhancing returns is to control portfolio costs. Investment Advisors must disclose any conflict, or potential conflict, to the client prior to and throughout a business engagement. Investment Advisors must adopt a Code of Ethics and fully disclose how they are compensated.
High net worth, high income households are often easy targets for bad advice. When hiring an advisor, a considerable amount of thought and research should be dedicated to the process. After all, it’s only your money. Here are some things you should ask when engaging a financial professional:
- How are you paid?
- Are your recommendations in any way influenced by compensation?
- What is your investment philosophy?
- Do you provide an Investment Policy Statement? (If you don’t know what that is—find out!)
- How much authority will you exert over my accounts?
- Do you have a clean regulatory record?
- What are your credentials?
- What is your educational background?
- How much experience do you have?
- What are your continuing education requirements?
Finally, you should also request and review the advisor’s written disclosure statement, ADV part I and II.
Unlike other professions like accounting or law, the financial industry does not have one standard designation or brand (think CPA and Esquire or J.D.) Instead we have a wide array to choose from. Most financial professionals would agree that the CFP® designation offers the most robust, well rounded financial education available to financial practitioners and it carries the most clout. It encompasses multiple areas of study which include taxation, retirement planning, insurance planning, estate planning, investment planning and case studies. Yet, this does not imply that every CFP® has the same investment philosophy or standard of care in dealing with clients. In fact, CFP® designation is held by advisors operating in two very distinct worlds: 1) the traditional brokerage firms/Trust companies that may charge commissions or peddle proprietary funds and 2) the more consumer friendly independent fee-only (or fee-based) side of the industry.
In summary, a consumer should demand that their advisor sign on as a fiduciary in writing. Stock brokers and Registered Representatives (RR) cannot do this. Conversely, an independent Registered Investment Advisor (RIA) is always a fiduciary, and should have no problem signing a fiduciary oath for his client. But, remember that where an RIA is also an RR, the investor must clearly understand that most likely that advisor is not operating as a fiduciary. Remember that credentials do not always translate into your success. Bottom line—do your homework before you hire!