If you’re in the process of choosing a financial advisor, you may have seen the term “fee-only” and wondered what that means.
As with many things in the financial world, the term makes perfect sense to industry insiders, but isn’t necessarily clear to would-be clients.
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Fee-only financial advisors charge clients for their services through transparent fees. They don’t earn commissions or incentives from financial products they recommend. For example, an advisor might charge a fee for developing a financial plan, or base their fee on a percentage of assets a client has under management, or bill clients via a subscription model with a monthly or quarterly flat fee.
The fee-only system is designed to encourage unbiased advice aligned with clients’ best interests, as it removes an advisor’s incentive to recommend a product, such as an annuity or mutual fund, to receive a sales commission.
Here’s how that may work in practice.
— Fee-only advisors’ primary focus is your best interest.
— You clearly understand what you’re paying for.
— Fee-only advisors take a big picture approach.
— Potential drawbacks of fee-only financial advisors.
— Even fee-only advisors can make errors.
— Fee-only advisors may not be the most affordable option.
— You may not get access to some services or products.
Fee-Only Advisors’ Primary Focus Is Your Best Interest
Fee-only advisors adhere to the fiduciary standard, the regulatory term for an obligation to act in the client’s best interest.
“Their standard of advice is much higher than practitioners who practice under the suitability standard,” says Marianela Collado, CEO and senior financial advisor at Tobias Financial Advisors in Plantation, Florida.
“The reason for this higher standard of care is because 100% of their revenue and compensation comes from the client,” she adds.
You Clearly Understand What You’re Paying For
Suppose you’re working with a fee-only financial advisor. In that case, it should be easy to understand what you’re paying for, whether it’s a percentage of assets under management, a planning fee or some other arrangement.
In commission-based arrangements, your charges are baked into the investments and financial products you own, so it may not be clear what services you’re receiving in exchange for the commissions you’re paying.
“Commissions are generally predetermined based on the product so there may be less flexibility around the cost and service structure,” says Ronnie Cox, investment director at San Francisco-based Human Interest Advisors.
[READ: What Is a Self-Directed IRA? Pros and Cons of This Unique Investment Account]
Fee-Only Advisors Take a Big Picture Approach
If an advisor not only creates your plan but updates it regularly and also tailors your investment allocation to align with your plan, they have a comprehensive view of your situation.
“While some fee-only advisors will focus on certain aspects of the financial planning process or niche groups, most act as holistic financial advisors covering topics such as cash flow analysis, retirement planning, insurance, estate planning, investments and sometimes taxes,” says Stephen Kates, a certified financial planner and principal financial analyst for Annuity.org.
Potential Drawbacks of Fee-Only Financial Advisors
While the fee-only system is more transparent and client-focused than the commission-based system, there are still possible pitfalls.
“The idea of fee-only should eliminate conflict of interest, but depending on the fee arrangement — which could range from a flat-fee dollar amount to a percentage of fees or hourly — they could have conflicts,” says Collado.
For example, she says, an advisor who is being compensated based on a percentage of managed assets may be incentivized to keep those assets and not recommend a strategy where the assets leave their management. That situation might include a client who wants to liquidate managed assets to pay off a mortgage.
Even Fee-Only Advisors Can Make Errors
No professional can completely avoid errors, but the key is how the advisor owns up to it and corrects it.
“Financial planning is not a perfect science, and one of the most important factors for success is finding an advisor that you align with from a strategy perspective so your expectations match your outcomes,” says Kates.
Investors who believe they have been harmed by an advisor’s mistake can file a written complaint to the advisor and the Financial Industry Regulatory Authority (FINRA) or the Securities and Exchange Commission (SEC).
Fee-Only Advisors May Not Be the Most Affordable Option
Prospective clients should always shop around before hiring an advisor to understand exactly what they are getting for their money.
“They should also meet with and interview their financial professional to make sure their approach aligns with your priorities,” says Cox. “This ideally is a long-term relationship you will have with your financial professional. Make sure you perform upfront due diligence to ensure it is a good fit for you and benchmark their fees and services with other available advisors.”
You May Not Get Access to Some Services or Products
While fee-only advisors can’t sell commission-based products, such as annuities and other insurance products, they can refer clients to other professionals if necessary.
“Most established advisors or advisor firms will have partnerships with other professionals such as estate planning attorneys, accountants or insurance agents,” says Kates.
“Fee-only advisors want to maintain their status as a fiduciary and therefore will minimize conflicts of interest,” he adds. “However, this doesn’t mean that they cannot still guide and advise you on these products or services as an unbiased third-party in conjunction with another professional.”
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Pros and Cons of Using a Fee-Only Financial Planner originally appeared on usnews.com
Update 04/29/24: This story was previously published at an earlier date and has been updated with new information.
