There is a simple but undeniable truth in the financial consulting and wealth planning industry that Wall Street provides kept as a “dirty little secret” for years. That dirty little, plus nearly always overlooked secret is THE METHOD YOUR FINANCIAL ADVISOR IS COMPENSATED DIRECTLY AFFECTS THEIR FINANCIAL TIPS TO YOU!
You want, and deserve (and consequently SHOULD EXPECT) unbiased economic advice in your best interests. But the fact is 99% of the general investing public has no idea how their financial advisor is compensated for the guidance they provide. This is a tragic oversight, yet an all too common one. You will find three basic compensation models intended for financial advisors – commissions based, fee-based, and fee-only.
Commission Based Financial Advisor – These experts sell “loaded” or commission paying products like insurance, annuities, plus loaded mutual funds. The commission rate your financial advisor is gaining on your transaction may or may not be disclosed to you. I say “transaction” because gowns what commission based financial experts do – they facilitate DEALINGS. Once the transaction is over, you may be lucky to hear from them again because they are yet to already earned the bulk of whatever percentage they were going to earn.
Since these advisors are paid commissions which might or may not be disclosed, and the amounts may vary based on the insurance and expense products they sell, there is an inherent discord of interest in the financial advice given to you and the commission these financial advisors earn. If their income is dependent upon transactions and selling insurance and 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 clearly this identifies a conflict appealing.
Fee Based Financial Advisor – Here is the real “dirty little secret” Wall structure Street doesn’t want you to learn about. Wall Street (meaning the companies and organizations involved in buying, offering, or managing assets, insurance plus investments) has sufficiently blurred the particular 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 Consultant is directly correlated with “honest, honest and unbiased” financial advice.
The truth is FEE-BASED MEANS NOTHING! Think about it (you’ll understand more when you learn the third type of compensation), all fee-BASED indicates is that your financial advisor can take costs AND commissions from selling insurance coverage and investment products! So a “base” of their compensation may be tied to a percentage of the assets they handle on your behalf, then the “icing on the cake” is the commission income they can possibly earn by selling you payment driven investment and insurance items.
Neat little marketing trick right? Lead off with the word “Fee” so the general public thinks the payment model is akin to the likes of attorney’s or accountants, then add the word “based” after it to cover their tails when these advisors sell a person products for commissions!
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FEE ONLY Financial Advisor – By far, the best and unbiased way to get economic advice is through a FEE-ONLY monetary advisor. I stress the word “ONLY”, because a truly fee ONLY financial advisor CAN NOT, and WILL NOT accept commissions in any form. A Fee-ONLY financial advisor earns FEES in the form of hourly compensation, project financial planning, or a percentage of assets managed on your behalf.
All fees are in black and white, there are no hidden forms of payment! 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 agents 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 true way to get the most unbiased, honest plus ethical advice possible and that is through a financial advisor who believes within, and practices, full disclosure.
Payment and Fee-Based financial advisors typically 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 a moment you need to buy a truck specifically for towing and hauling heavy tons. You go to the local Ford dealership and talk to a salesperson – that will salesperson asks what type of vehicle you have in mind and shows you their line of vehicles. Of course , to that salesperson who makes a commission when you buy a pickup truck – 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 salesman you’re crazy!
The fact is Toyota makes great trucks, GM makes great trucks, Dodge makes great trucks. The Ford may or may not be the best vehicle for your needs, but the salesperson ONLY teaches 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. When they sell annuities, they’ll show you annuities. If they sell mutual funds, all they’ll show you is commission paying out mutual funds. If they sell life insurance coverage, they’ll tell you life insurance is the means to fix all of your financial problems. The fact is, when all you have is a hammer… everything appears to be a nail!
Now consider for the moment you hired a car purchasing advisor and paid them a flat fee. That advisor is an expert and stays current on all of 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 fee 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 dealerships to get you the best price on the truck that’s 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 accessible investments with the lowest possible price. A Fee-Only financial advisor’s just incentive is to keep you happy, in order to earn your trust, to provide the best possible financial advice and guidance utilizing 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 purchase the truck the more they gain! ) to sell you one of the vehicles off their lot. On the other hand, you do have a trusted car buying advisor who shops all of the vehicles to find the most suitable one for your specific needs, and after that because of his relationships with all of the vehicle dealers can also get you the best possible cost 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’re paying and what you’re getting in come back for the compensation your Fee-Only monetary advisor earns. Everything is in black and white, and there are no hidden agenda’s or conflicts of interest in the advice 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 disparity in a financial advisor’s income generated through commissions (or commissions and 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, 000 401k into an IRA. The particular commission based advisor may sell you a variable annuity in your IRA (which is a very poor planning tactic in most cases and for many reasons) plus earn a 5% (or many times more) commission ($12, 500) and get an ongoing, or “trailer” commission of 1% (plus or minus) equal to $2, 500 per year. The Fee-Only financial advisor may charge you the fee for retirement plan, an hourly fee, or a percentage of the portfolio to manage it. Let’s say in this case you pay a $500 retirement plan fee and 1 . 25% of assets managed (very common for a Fee-Only financial advisor in this particular situation). That advisor earns $250 plus $3, 125 ($250, 1000 * 1 . 25%) or COMPLETE COMPENSATION of $3, 625 : FAR LESS THAN THE $15, 000 THE PARTICULAR COMMISSION (or Fee-Based) financial advisor 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 12 months!
Example #2 – You’re outdated and managing a $750, 000 home egg which needs to provide you earnings for the rest of your life. A fee-based monetary advisor may recommend putting $400, 000 into an single superior immediate annuity to get you income and the other $350, 000 into a fee-based managed mutual fund platform. The particular annuity may pay a commission payment of 4% or $16, 1000 and the fee-based managed mutual account portfolio may cost 1 . 25% for total compensation of 20 dollars, 375 first year (not including the “trailer” commissions). The Fee-Only consultant would possibly shop low load annuities for you, possibly put the entire profile into a managed account, possibly take a look at municipal bonds, or any other number of options available. It’s hard to say how much the Fee-Only advisor would make as their largest incentive is to keep you the client happy, and provide the best preparing advice and guidance possible for your situation. BUT , in this case let’s just imagine a managed mutual fund profile was implemented with an averaged price of 1% (very common for that degree of assets), so the Fee-Only financial consultant earns roughly $7, 500 each 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 today’s financial advisory industry. It’s unfortunate that such a disparity in income exists between the compensation models, or there would likely be many more truly 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 advisor must consistently earn your believe in and add value to your economic and investment planning? It’s apparent the financial advisor with the most to reduce is the Fee-Only advisor. A Fee-Only financial advisor has a direct loss of income on a regular basis from losing a client.
The commission or fee-based monetary advisor however has little to shed. You can fire them after they are yet to put you in their high payment products, and as you can see from the examples they’ve already made the majority of the income they’re going to make on you as a customer. They have little to gain by ongoing to add value to your financial and investment planning, and little to shed by losing you as a client.