Most people who work with a financial advisor have some idea of what they’re paying. What they may not know is whether there are other ways the advisor or the firm gets compensated.
I think that’s an important distinction.
A fee-only advisor is compensated by clients and doesn’t receive commissions from investment or insurance products. A fee-based advisor may charge an advisory fee while also receiving commissions or other sales-related compensation.
That doesn’t mean a commission automatically makes a recommendation bad. I use a simple example in this week’s podcast: imagine your waiter recommends a bottle of wine, but you later learn he gets an extra $50 every time somebody orders it. He may genuinely think it’s a great bottle of wine. You’d probably just want to know about the $50.
The same idea applies to financial advice.
There’s another distinction that tends to get mixed into this conversation: fee-only and fiduciary are not the same thing. Fiduciary refers to the obligation to put the client’s interests first. Fee-only describes how someone gets compensated.
And even fee-only fiduciary firms have conflicts.
For example, if an advisor charges a percentage of assets under management and a client is considering withdrawing $300,000 to pay off a mortgage, the advisor may earn less if the client does it.
We run into decisions like this all the time. The answer shouldn’t be based on what keeps more money in the account. You have to look at the mortgage rate, taxes, available cash flow, liquidity, how the client feels about debt and what the decision does to the rest of the retirement plan.
In other words, the conflict isn’t necessarily the problem. Pretending it doesn’t exist is.
In this week’s episode of Wisdom for Your Wisdom Years, I break down the differences between fee-only and fee-based advice, what fiduciary means in practice, and some questions worth understanding when you’re evaluating an advisory relationship.
