Fee-Only vs. Fee-Based vs. Fiduciary Advisors: What You Need to Know to Secure Your Financial Future

When it comes to creating a financial plan, choosing the right financial advisor is crucial. But with so many different types of advisors out there, it can be confusing to know which one is best suited to your needs. Unfortunately, the advisory profession and the regulatory landscape combine to create confusion about what type of advisor is most conflict-free. While fee-only and fee-based advisors may sound similar, there are key differences between them that can have a significant impact on your financial future. And how does “fiduciary” fit into all of this?

What is a Fee-Only Financial Advisor?

A fee-only financial advisor is compensated solely through the fees paid by their clients. These fees can be charged in various ways, such as:

• Hourly fees for the time spent on your financial planning.
• Flat fees for a specific service or financial plan.
• A percentage of assets under management (AUM), where the advisor earns a percentage of the assets they manage on your behalf.

Importantly, fee-only advisors do not receive commissions or compensation from third-party product sales, such as insurance policies or investment products. This compensation structure minimizes potential conflicts of interest, as fee-only advisors have no financial incentive to recommend specific products. Their primary focus is on providing unbiased advice that aligns with your best interests.

What is a Fee-Based Financial Advisor?

A fee-based financial advisor, on the other hand, earns income through a combination of client fees and commissions from the sale of financial products. Like fee-only advisors, they may charge fees for services, but they can also receive commissions or incentives from insurance companies, mutual fund providers, or other financial institutions for recommending certain products.

This dual compensation model creates conflicts of interest. While fee-based advisors may provide valuable advice, their recommendations could be influenced by the commissions they stand to earn. This means that even if a particular financial product isn’t the best option for you, it could be recommended because it offers a higher commission to the advisor.

Key Differences Between Fee-Only and Fee-Based Advisors

Understanding the differences between fee-only and fee-based advisors can help you make a more informed decision about who to trust with your financial future:

Compensation Structure:

Fee-Only: Paid exclusively by clients through fees, with no commissions or incentives from third parties. The only person compensation the advisor is you, the client.

Fee-Based: Paid through a combination of client fees and commissions from selling financial products.

Conflict of Interest:

Fee-Only: required to avoid and disclose any potential conflicts of interest. Since there are no financial incentives tied to recommending specific products, fee-only advisors are typically free of conflicts of interest.

Fee-Based: Advisors who are paid from commissions earned from product sales have a conflict of interest, some do a better job disclosing this than others.

Transparency:

 Fee-Only: Advisors who are members of NAPFA are required to be transparent about their compensation, disclosing all fees upfront and in writing.

Fee-Based: Some fee-based advisors are forthright about how they are compensated, while others are not. This lack of transparency around fees and commissions can make it harder to understand their incentives.

Which Advisor is a Fiduciary?

Fee-Only: Fee-only advisors always and only serve as fiduciaries. An important distinction to make is this; all fee-only advisors are fiduciaries, but not all fiduciaries are fee-only.

Fee-Based: While some fee-based advisors may act as fiduciaries in certain circumstances, their dual compensation structure leads to conflicts.

Advisors Who Wear “Two Hats”

The concept of a "two hat" advisor refers to a financial professional who operates under two different regulatory standards depending on the services they are providing at any given time. This often involves an advisor acting in dual roles: serving as a fiduciary in one capacity and as a commissioned insurance salesman – and often not disclosing to the client the differing standards that apply.

How It Works

Hat #1 - Serving as a Registered Investment Advisor (RIA):

• Fiduciary Duty: When wearing the first "hat," the advisor operates as a Registered Investment Advisor (RIA) or under the RIA firm, which requires them to act as a fiduciary. This means they must act in the best interest of their clients, providing advice that is unbiased and free from conflicts of interest.
• Compensation: In this role, the advisor is typically compensated through fees, such as a percentage of assets under management (AUM), hourly rates, or flat fees. They do not earn commissions from selling financial products.

Hat #2 - Broker/Insurance Agent Role:

• Suitability Standard: When wearing the second "hat," the advisor acts as a broker or an insurance agent. In this role, they are held to a "suitability" standard rather than a fiduciary standard. This means they can recommend products that are suitable for the client’s needs, even if those products are not necessarily in the client's best interest.
• Compensation: In this capacity, the advisor may earn commissions from the sale of financial products, such as mutual funds, insurance policies, or annuities. This creates a potential conflict of interest, as the advisor might be incentivized to recommend products that pay higher commissions.

Why It Matters

The "two hat" approach can be confusing for consumers because it’s not always clear which hat the advisor is wearing at any given time. This can lead to misunderstandings about whether the advisor is putting your interest first or in a capacity where they might prioritize their own financial gain. Here are two main drawbacks of working with a "two hat" advisor:

Lack of Transparency & Lack of Disclosure: Clients might not be aware of when the advisor is switching roles, which can lead to recommendations that aren’t fully aligned with your best interests.

Commission vs. Fee-Only Advice: The advisor might recommend products that generate higher commissions rather than those that are truly best for you. We see this often involving the sale of fixed index annuity products.

Which Type of Financial Advisor is Right for You?

Choosing between a fee-only and fee-based advisor depends on your personal preferences and financial goals. If you seek unbiased advice and no potential conflicts of interest, a fee-only advisor is the best choice. Their compensation structure ensures that their recommendations are based solely on what’s best for you, without the influence of third-party incentives. At Ark Royal Wealth Management we're proud to always and only be fee-only advisors!