fee-only vs. fee-based- choosing a financial advisor
TRANSCRIPT
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 1
6-‐Year Breakeven Point: Fee-‐Only VS Fee-‐Based Executive Summary
Do you know how your financial advisor is compensated? Are you aware of
his or her conflicts of interest when advising you? Do these conflicts of interest
affect your advisor’s ability to act objectively in a fiduciary manner? When does it
make sense to use a Fee-‐Only versus a Fee-‐Based advisor? This article is designed to
help you learn more and start asking the tough questions.
Ultimately, you want you and your advisor’s interests to be aligned. You want
to know that a recommendation he or she makes
is always in your best interest and not born out
of a desire to increase the advisor’s
compensation. You want your advisor to remain
objective, to minimize conflicts of interest, and to
disclose remaining conflicts of interest.
Another aspect to consider is when does it make sense to engage a Fee-‐Only
planner who charges a flat fee versus a Fee-‐Based advisory who has the ability to
charge a commission based on the product being considered. Based on analytical
studies of fee structures, it takes roughly 6 years for an account hit with an upfront
5% fee to catch up to an account with a yearly 1% asset under management fee. If
another trade is made before the 6 year mark, the economics are in favor of the AUM
yearly fee. What is more is that this phenomenon exists regardless of the initial
invested amount and the expected rate of return on the investment account.
Read on to help you decide whether Fee-‐Only versus Fee-‐Based is right for
you. In the appendix, you will find a tool developed by The National Association for
Personal Financial Advisors to help you engage your current or future financial
advisor.
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 2
6-‐Year Breakeven Point:
Fee-‐Only VS Fee-‐Based
Do you know?
Do you know how your financial advisor is compensated? Are you aware of
his or her conflicts of interest when advising you? Do these conflicts of interest
affect your advisor’s ability to act objectively in a fiduciary manner? When does it
make sense to use a Fee-‐Only versus a Fee-‐Based advisor? This summary is
designed to help you learn more and start asking the tough questions.
Compensation
It is important to know how your financial advisor is getting paid. Are they
getting paid commissions for selling you products including investments, insurance,
and annuities? What are the resulting implications?
A Fee-‐Only financial advisor gets paid a flat fee which is calculated either
hourly, by the project, by a percentage of assets under management, or by a
percentage of the client’s net worth. Fee-‐Only advisors do not
receive any compensation from referrals or products they sell
you. Assets under management fees typically range from 1-‐2%
and may be tiered based on the level of wealth. Larger portfolios
tend to have a lower percentage fee. Many Fee-‐Only planners
have minimum account requirements or charge a minimum fee to
cover services offered including comprehensive planning, investment
recommendations, and implementation. In terms of insurance, Fee-‐Only advisers
typically assess your needs as part of the planning process and simply advise you on
how much and what to get. They do not receive portions of the premium or
commission on the policy sale (Bergen).
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 3
A Fee-‐Based advisor can charge either the previously mentioned advisory fee
or commissions on products or referrals they make to you. Fee-‐Based is a term the
brokerage community developed to counteract the success of the Fee-‐Only
classification (Wealth Engineering). One advisor interviewed said, “I think ‘fee
based’ is a euphemism invented to make it sound like ‘fee only’ which it is not. In
my opinion, a more honest label would be ‘commission and fee’.” A Fee-‐Based
advisor we interviewed said:
I can be compensated in numerous ways. How I am compensated from my
clients is really up to them. I can charge an annual fee based on assets under
management, or I can be paid based on the type of investment that fits my
client’s needs. I am always 100 percent transparent with clients on how I am
compensated, and always allow them to choose the manner in which they pay
for my services… We stress transparency and doing what is best for the client.
How much the advisor can make on commissioned products varies which
brings us to the next topic.
Conflicts of Interest and Objectivity
You want to know that an advisor’s recommendation is really what is best for
you, not just the advisor. For a Fee-‐Only planner, advice is totally independent of
the financial products recommended (Wealth Engineering). Fee-‐Only advising
eliminates many conflicts of interests, but there are
scenarios to consider. Let us say you wanted to take out
$250,000 of your investment portfolio to pay off a mortgage
or invest in rental properties. The payout to your advisor is
less because the assets under management would be less even though your net-‐
worth has not changed. Depending on your circumstances, paying off debt may be
more prudent for you, and you want to make sure your advisor truly recommends
what is your best interest, even if it is not in theirs (Wohlner). Some advisors avoid
this scenario by charging a percentage of your net worth regardless of where it is
invested.
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 4
Many Fee-‐Based advisors are registered reps for larger brokerages, which
means they are compensated by the brokerage firm based on the products they sell.
You can think of them as glorified sales people. Some advisors are limited in
products they can recommend based on the offering of the broker they work for.
This brings us to the point that they are working for the broker, not for you.
Brokers have monetary incentives to steer large investors away from share
classes with load-‐reducing breakpoints and to steer short-‐term investors to
high-‐load, low annual fee classes. This conflict of interest between fund
investors and brokers is most dangerous when brokers advise relatively
uninformed investors who likely make up a significant fraction of investors who
retain advisors on mutual fund investments (Dr. Edward S. O'Neal).
Another problem with transaction-‐based fees is the advisor’s temptation to over-‐
trade your account to generate fees, known as churning. Many regulations and
internal controls are in place to help mitigate this dilemma.
Fee-‐Only planners are legally obligated to work as a fiduciary on your behalf.
This basically means they must make recommendations that are in your best
interest at all times. Fee-‐Based planners are
only required to operate under the suitability
requirement. This means that investment
recommendations must generally meet the
objectives and means of you the investor
(Investopedia). Suitable recommendations do
not necessarily represent the best available recommendations. Therefore, a
commissioned advisor may choose the higher commissioned product as long as it
generally meets your investment objectives and budget. See a description of the
Fiduciary Oath attached in the Appendix (NAPFA).
The National Association of Personal Financial Advisors’ core position is that
Fee-‐Only engagement removes the potential conflicts of interest that are inherent in
a commission relationship. NAPFA is the largest professional organization of fee-‐
only financial advisers in the country.
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 5
Commission-‐based advisors may receive higher commissions on certain
products they sell than on others. This may
influence their decision to recommend
investment products that are not in your
best interest. Ideally, you want an advisor
who offers objective advice based solely on
your specific needs, not the difference in
advisor’s compensation.
Ultimately, you want an advisor who aligns the interests of the client and the
advisor, sitting on the same side of the table. A Fee-‐Only advisor is incentivized to
earn more money by growing your portfolio, generating a percentage of a larger
asset base. The more money you make, the more the advisor can make. You do not
have to worry if a trade recommendation is being made in order to profit you or
create a revenue opportunity to the advisor. Alternatively, if an advisor is
incentivized to sell a product which may or may not be in your best interest, a
conflict of interest arises.
The 6-‐year Breakeven Point
Let us do a cost comparison of fees under both the commission and the
advising fee structure. For this comparison, assume that the Fee-‐Only advisor will
charge 1% of assets under management, calculated and paid quarterly. Similarly,
assume the commission rate is an upfront 5% fee. Assume a fixed rate of return in
both scenarios of 7% annually on a portfolio with an initial investment of
$1,000,000. The results show that it takes 6 years of holding an investment
position before the value of the investment account that took the upfront hit
(Fee-‐Based commission) catches up to the Fee-‐Only account. Figure 1 below
shows the results of the data analysis. What is even more interesting is that when
the amount of the initial investment and/or the assumed rate of return are varied,
the results are the same: a 6-‐year breakeven point!
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 6
Figure 1 Investment Account Balance Comparison
What does this mean? It means that if you plan to hold your purchase of a stock,
bond, mutual fund, etc. for less than 6 years, it costs you more with the commission
model. Data and graphs for the following scenarios are located in the Appendix:
$50k initial investment with a 7% rate of return and a $50k initial investment with a
10% rate of return. Again, both will confirm the 6-‐year breakeven point
phenomenon.
Who is best served by the Fee-‐Only Planner?
If you have a larger portfolio that requires frequent trades and active asset
allocation to meet its objectives, Fee-‐Only planning is certainly the way to go. A Fee-‐
Only advisor interviewed recommends his model to “anyone who meets the
minimums. Most do, it just may be hourly planning rather than AUM.”
$950,000
$1,050,000
$1,150,000
$1,250,000
$1,350,000
$1,450,000
$1,550,000
1 2 3 4 5 6
Investment Account Balance
Years Invested
Investment Account Balance Comparison Initial Investment: $1M, Assumed 7% growth
1% Advisory Fee
5% Commission
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 7
With the previously mentioned topics and now including the actual cost comparison
of fees, a Fee-‐Only planner would better serve most clients. Conflicts of interests are
reduced greatly and they are required to operate under the fiduciary oath.
Who is best served by the Fee-‐Based planner?
The client who is best served by a Fee-‐Based planner is one whose objectives
require less active management. The “buy and hold method” works best with the
commission model rather than the ongoing assets under
management fee. Consider the situation where an individual
inherits company stock from his or her grandfather’s
passing. Based on personal reasons, this individual never
really intends to sell the stock. It does not make sense to
continue to charge an on-‐going management fee for
something that does not involve active management.
One advisor interviewed says Fee-‐Based planning is for “someone who can't
or won't do it themselves but can't meet the minimum for Fee-‐Only.” Similarly,
many smaller portfolio accounts would suffer from frequent trading due to
associated trading costs. A one-‐time commission fee would mathematically make
more sense. A Fee-‐Based planner interviewed said the following:
Whether the client wants to pay an up front fee for the service I provide, or pay
an annual fee, that is up to them. It is my job to ensure they know the
different options of payment available to them and that I build them a strong
portfolio designed to help them reach their goals.
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 8
Ask your advisor if you have not already done so.
Whether you are interviewing a
new advisor or have been with one for
many years, it is important to know how
they get paid and how are they
incentivized to make more money. Ask
to see the advisor’s form ADV and firm
brochure which outline all forms of
compensation, relationships with other financial institutions, and other potential
conflicts of interest. In the Appendix is NAPFA’s convenient form that guides you
through asking the tough questions. Remember the 6-‐year breakeven point fee
comparison. It is important for you to know this information to make sure the
advice you are getting is in your best interest at all times. Ultimately, you need
transparency and full disclosure of compensation to make the best decision for your
financial goals.
Daniel Hannoush, MS Founder | Financial Advisor [email protected] 404.374.5486
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 9
Works Cited Bergen, J. V. (n.d.). Paying Your Investment Advisor -‐ Fees or Commissions? Retrieved 4 21, 2015, from Investopedia: http://www.investopedia.com/articles/basics/04/022704.asp Dr. Edward S. O'Neal, P. (n.d.). Mutual Fund Share Classes and Conflicts of Interest between Brokers and Investors. Retrieved 4 20, 2015, from Securities Litigation & Consulting Group: http://www.slcg.com/pdf/workingpapers/ONealonShareClasses.pdf Investopedia. (n.d.). Suitable (Suitability). Retrieved April 20, 2015, from Investopedia: http://www.investopedia.com/terms/s/suitable.asp NAPFA. (n.d.). How to find Your financial advisor. Retrieved 4 21, 2015, from The National Association of Personal Financial Advisors: www.napfa.org/Howtofindanadvisor.asp Wealth Engineering. (n.d.). What is the Difference Between "Fee-‐Only" and "Fee-‐Based?". Retrieved April 21, 2015, from Wealth Engineering, We Build Financial Peace of Mind: �http://wealth-‐engineering.com/what-‐is-‐the-‐difference-‐between-‐fee-‐only-‐and-‐fee-‐based/ Wohlner, R. (n.d.). Fee-‐Only Financial Advisers: What You Need to Know. Retrieved 4 20, 2015, from Investopedia: http://www.investopedia.com/articles/investing/102014/feeonly-‐financial-‐advisers-‐what-‐you-‐need-‐know.asp *(3) Fee-Based and (1) Fee-Only Advisors were interviewed. Each requested their name and firm be left anonymous for compliance purposes.
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 10
Fiduciary Oath
The advisor shall exercise his/her best efforts to act in good faith and in the best interests of the client. The advisor shall provide written disclosure to the client prior to the engagement of the advisor, and thereafter throughout the term of the engagement, of any conflicts of interest, which will or reasonably may compromise the impartiality or independence of the advisor.
The advisor, or any party in which the advisor has a financial interest, does not receive any compensation or other remuneration that is contingent on any client's purchase or sale of a financial product. The advisor does not receive a fee or other compensation from another party based on the referral of a client or the client's business.
Following the NAPFA Fiduciary Oath means I shall:
- Always act in good faith and with candor - Be proactive in disclosing any conflicts of interest that may impact a client - Not accept any referral fees or compensation contingent upon the purchase or sale of a financial product
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 11
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 12
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 13
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 14
$47,000
$52,000
$57,000
$62,000
$67,000
$72,000
1 2 3 4 5 6
Investment Account Balance
Years Invested
Investment Account Balance Comparison Initial Investment: $50k, Assumed 7% growth
1% Advisory Fee
5% Commission
$48,000
$53,000
$58,000
$63,000
$68,000
$73,000
$78,000
$83,000
1 2 3 4 5 6
Investment Account Balance
Years Invested
Investment Account Balance Comparison Initial Investment: $50k, Assumed 10% Growth
1% Advisory Fee
5% Commission
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 15
NAPFA: CONSUMER TOOLSBeing armed with the right questions is vital in understanding an advisor’s motivations and whether or not they are going to work in your best interests.
Here are some questions to get you started!
Tough Questions To Ask Your AdvisorWhat is your educational background?
College Degree: Graduate Degree:
What are your financial planning credentials/designations and affiliations?
NAPFA-Registered Financial Advisor Certified Financial Planner (CFP) Chartered Financial Consultant (ChFC) Certified Public Accountant/Personal Financial Specialist (CPA/PFS) How long have you been offering financial planning services?
_____ years and _____ months
Do you have clients who might be willing to speak with me about your services?
Yes No
Will you provide me with references from other professionals?
Yes No
Have you ever been cited by a professional or regulatory governing body for disciplinary reasons?
Yes No
What more can you tell me about your experience in providing financial planning services?
How many clients do you work with?
Number of clients: _____
Are you currently engaged in any other business, either as a sole proprietor, partner, officer, employee, trustee, agent or otherwise?
Yes No
Will you or an associate of yours work with me?
You will Associate Team
Will you sign a Fiduciary Oath?
Yes No
How is your firm compensated and how is your compensation calculated?
Fee-Only Commissions Only Fee and Commissions (Fee-Based) Fee-Offset
Do you have an agreement describing your compensation and services that will be provided in advance of the engagement?
Yes No
APPENDICES
6-‐YEAR BREAKEVEN POINT: FEE-‐ONLY VS FEE-‐BASED 16
For additional tools to help you properly review the qualifications of a financial advisor, visit www.NAPFA.org and click on “Consumer Information”.
Tough Questions To Ask Your AdvisorDo you have a minimum fee?
Yes No
If you earn commissions, approximately what percentage of firm’s commissions comes from:
Insurance Products Annuities Mutual Funds Limited Partnerships Stock and Bonds Coins, Tangibles, Collectibles Other
Does any member of your firm act as a general partner, participate in, or receive compensation from investments you may recommend to me?
Yes No
Do you receive referral fees from attorney, accountants, insurance professionals, mortgage brokers, or others?
Yes No
Do you receive on-going income from any mutual funds that you recommend in the form of 12b(1) fees, trailing commissions, or other continuing payouts?
Yes No
Are there financial incentives for you to recommend certain financial products?
Yes No
Do you offer advice on:
Goal setting Cash management and budgeting Tax planning Investment review and planning Estate planning Insurance needs Education funding Retirement planning Other
Do you provide a comprehensive written analysis of my financial situation and recommendations?
Yes No
Does your financial planning service include recommendations for specific investments or investment products?
Yes No
Do you offer assistance with implementation of the recommendations?
Yes No
Do you offer continuous, on-going advice regarding my financial affairs, including advice on non-investment related financial issues?
Yes No
Do you take custody of, or have access to my assets?if you were to provide me on-going investment advisory services, do you require “discretionary” trading authority over my investment account?
Yes No