Fee-Only vs. Fee-Based vs. Commission-Based Advisors
|Fee-Only Advisors||Fee-Based Advisors||Commission-Based Advisors|
Fee-Only Financial Advisors and the Fiduciary Standard
As a fee-only financial advisor, Petersen Hastings charges a fee that is based solely on a percentage of assets managed – which includes our advice and the on-going management of assets. Fee-only financial advisors must also be completely transparent with their fee structures, and by doing so, clients will always be aware of what they are paying. Fee-only advisors receive no other financial reward from any other source. This means we never receive referral fees or commissions, and therefore have no incentive to push one product over another. We simply advise on what will be the best investment for the client’s situation. This compensation structure aligns our goals with the clients’.
This unique way in which we are paid allows us to be objective in our advice and avoid possible conflicts of interest. As a fee-only Registered Investment Advisor (RIA), we are held legally to a Fiduciary Standard, which means by law we must hold the client’s interests above our own.
For example, Petersen Hastings does not receive compensation from any source for directing a client to the purchase or sale of any specific security or product. Our only source of compensation is fees paid by the clients themselves.
Fee-Based Financial Advisors and the Suitability Standard
Fee-based advisors may be paid by clients but also by other sources, such as commissions from financial products that clients purchase. The entities of the financial company then pay part of this to the advisor. In the investment world these fee-based advisors are commonly known as broker/dealers. These fee-based advisors work as financial salesmen – selling clients a product that provides the advisor with sales commission.
The potential problem lies in the possibility of a conflict of interest between the client and the advisor. The commissions provide an incentive to sell products with the highest payout to the advisor, regardless of whether they are the best option for the client.
Commission-Based Financial Advisors
Commission-based compensation is the oldest method, in which advisors are solely paid by a commission on each product they sell. Most stock brokers fall under this category. This is a fine system for a client who knows exactly what they want already, but it is ill-suited for an advice-giving setting. Commissions can hamper a long-term relationship built on trust and advice because it introduces doubt. Similar to the approach by fee-based advisors, a given product might not be best for the client. The commissions provide an incentive to sell products with the highest payout to the advisor, regardless of whether they are in the best interest of the client.
Before you begin to work with a financial advisor, whether at an independent firm, a large financial institution, or a broker-dealer, you really need to do your research and ask some tough questions, such as: What are the professional qualifications and educational background of the advisor? Where does his or her experience and expertise lie? How are they compensated? Are they held to a fiduciary standard? Why are they recommending a certain product to you? These are all great questions to consider when embarking on your financial journey and deciding on the right advisor for you.
Understanding the ABC’s of Mutual Fund Investing
The fee-based and commission advisors are reimbursed by mutual funds in exchange for the investments they sell. Most mutual funds with sales commissions come in three main share classes:
- Class A Shares: These funds charge what is called a “front load,” meaning that a client will pay a percentage of the purchase amount in the form of commission up front every time an investor buys shares, which reduces the purchase amount. For instance, a $1,000 investment with a 5% front load would net the investor with a $950 investment.
- Class B Shares: These funds charge a “back load,” which means you’ll pay a percent of the dollar value of shares sold (opposite of “front load”). You do not pay anything up front, but you do pay a pre-determined percentage when it’s sold.
- Class C Shares: These funds charge a “level load,” which means there is an ongoing fee as long as you hold the fund. This increases the expenses of the fund and drags down returns.