When you’re looking to hire a financial advisor, it goes without saying that you want someone you can trust. Part of building that trust comes down to understanding how your financial advisor gets paid. Maybe you’ve never heard the term “fee-only”, or maybe you have experience with “fee-based” advisors. In any event, the way your advisor makes money is a consideration that cuts to the heart of any advisor / client relationship. What drives him or her in offering the financial advice that can impact your life dramatically — both now and into retirement?
The answer is not always simple, but it’s worth doing your homework.
Fee-Only, Fee-Based, it’s all really confusing…
Take it from Dave Ramsey, a personal money-management expert, author and national radio host, who says a successful investment strategy involves spending money to make money. But you have to be smart about it.
“I know it’s hard to understand exactly how an investing advisor gets paid — and what you’re getting for your money,” Ramsey writes on his blog. “But I also know that successful investors work with financial advisors they trust. And if you’re going to reach your dream retirement, you need an advisor you can trust on your side.”
We couldn’t agree more. So let’s break down the basics. Financial advisors typically fall into two broad categories when it comes to compensation: fee-only and fee-based. They sound similar, which can cause some confusion among clients. But they are, in fact, very different.
A fee-only financial advisor is a registered investment advisor (RIA) with a fiduciary responsibility to act in the clients’ best interests. (You can learn more about what it means to be an RIA here.) That means they do not accept any compensation from third parties — namely the companies that sell the financial products they recommend.
Why does that matter? The fee-only model removes any potential conflicts of interest. The fee-only advisor is not motivated to sell you a particular product because of the money they stand to make off that sale. They get paid based on a flat fee, an hourly rate or a percentage of assets under management — which means their only motivation is to ensure they provide you with sound financial advice. That way, you become a happy customer who turns into a longtime and wealthy customer.
When that happens, everyone wins.
Fee-based advisors also charge their clients a fee for their advisory services. But that’s not the only way they get paid. Fee-based advisors also receive compensation through the sale of various financial products they recommend to their clients.
Fee-based advisors do not have a fiduciary responsibility (to act in their clients’ best interests). Instead, they are only required to offer “suitable” recommendations. That’s where the potential conflicts of interest come into play: The prospect of additional compensation can be hard to resist, even for the most well-intended advisors, and they may find themselves leaning toward one product over another simply because of how much money they could earn as a result.
When you’re choosing a financial advisor, one of the most important questions you can ask is how they get paid. RIAs are required to disclose their compensation in detail, so do your due diligence and ask. A well-informed investor is a better investor — every single time.