Finding out how your prospective financial advisor is compensated may be the most important question you can ask. Advisors can be paid through a fee, like an annual planning fee or percentage of assets managed (AUM fee), commissions or some combination. The goal here is transparency.
One of the most often misunderstood set of terms is the difference between fee-only and fee-based advisors.
- A fee-only advisor is paid directly by their clients for advice, including investment management, plan implementation, financial planning, and for the ongoing management of assets. Fee-only financial planners act as a fiduciary which means they are obligated to put their clients’ interests first. Registered Investment Advisors (RIAs) and Certified Financial Planners (CFP®s) are fiduciaries.
- A fee-based advisor can also be paid directly by clients but also via other sources, such as commissions from the sale of financial products clients purchase through them or their Broker/Dealer. These brokers and dealers are held to a lower legal standard which requires only that the products are determined to be ‘suitable’ for their clients. Suitability can be somewhat unclear if compensation is involved.
- The SEC’s Regulation Best Interest (Reg BI) under the Securities Exchange Act of 1934 establishes a “best interest” standard of conduct for broker-dealers and associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. As part of the rulemaking package, the SEC also adopted new rules and forms to require broker-dealers and investment advisers to provide a brief relationship summary, Form CRS, to retail investors. In addition, the SEC published interpretations concerning investment advisers’ standard of conduct under the Investment Advisers Act of 1940, and the “solely incidental” prong of the broker-dealer exclusion from the Advisers Act.
- If your advisor is fee-based, search for their firm’s Form ADV filing with the U.S. Securities & Exchange Commission. The document includes information that spells out how brokers at the company are compensated. (It’s a good practice to check Form ADV before you hire any financial advisor. In addition to explaining fee structure, it lists past misconduct if there is any.)
The National Association of Personal Financial Advisors’ (NAPFA) position is that the fee-only method of compensation is the most transparent and objective method available. This model minimizes conflicts and ensures that your financial planner acts as a fiduciary. Fee-only planners are compensated directly by their clients for advice, plan implementation and for the ongoing management of assets. They may be paid hourly, as a retainer, as a percentage of assets (AUM), or as a flat fee, depending upon the planner you choose.
In addition to how an advisor is paid, there are several other things to consider. About a year ago, I wrote a blog about the five things you should ask your wealth advisor to ensure they have the skills you need. The advice still holds true today. Much like a doctor/patient relationship, you will be sharing many personal details about your life for the planner to be able to appropriately diagnose your situation and offer you advice on how to improve your overall financial health.
Our team of wealth advisors here at BerganKDV are fee-only fiduciaries who are dedicated to helping you navigate all areas of your financial life. Want to learn more about what we can do for you? Start here.
The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.