Considering the current regulatory environment, new attention is being placed on the compensation of financial advisors. Although the primary concern should be what is best for the client, there is a vast difference of opinion regarding which is best: fees or commissions. While this debate will continue for the foreseeable future, it is increasingly important to understand the landscape.
When deciding on the best approach, there are at least five important considerations:
Conflict-free advice and objectivity. It is critical that the advice you receive is delivered in a conflict-free and objective structure. Are you certain the advice you are receiving is in your best interest, or could it be for the advisor or firm they represent to generate revenue? Do you ever harbor any doubts about this answer? As a rule, the fee structure should eliminate this concern. An advisor charging a level fee for advice does not get paid based on the number of transactions made. In contrast, the commission structure could encourage more active trading than what might be best in the long run.
Greater choice. At most wealth management companies, a fee-structured arrangement usually opens the door to almost all investment types from most money managers, fund companies, etc. The commission route will likely limit investment options strictly to those who pay commissions. This is particularly true in the world of mutual funds. It is also possible that the advisor’s broker-dealer or custodian has special arrangements with many fund companies and ETFs. This could unknowingly limit your choice or increase your cost. Do you see familiar low-cost fund managers in your portfolio such as Vanguard and T. Rowe Price, or is your portfolio limited to commission-based investment vehicles?
Aligned interest in keeping costs down. When an advisor charges a fee, this should be the only compensation they receive for their advice. In other words, they should not be receiving additional compensation from fund companies or money managers within your portfolio. Therefore, it should be in their best interest to keep costs down, aligning their interest with yours. Although the commission-based approach could be cheaper for some clients, the compensation structure certainly may not be aligned.
Do you understand the cost? Just because you don’t see the cost doesn’t mean it is free or the least costly. You should understand the imbedded expenses and commissions inside mutual funds, annuities, and insurance. Quite often, what you assume to be low cost is actually the most expensive. Also, just because you are paying a fee, don’t assume it is reasonable. Fees should be closely reviewed. If you don’t know, ask your advisor for an accounting of all costs — seen and unseen. If they are not completely transparent, this should be a warning sign.
Are you getting your money’s worth? Regardless of which compensation route you take, you should make sure you are getting the commensurate service and advice for the cost. If you are simply using an advisor to place trades, you may be best served at a discount or online broker. If you are paying full-service commissions or fees, at a minimum you should be receiving services such as investment planning, tax planning, estate planning, and insurance planning. In addition, you should expect regular meetings. It is not uncommon for us to hear prospective clients say they never hear from their advisor. If so, why would you pay them full freight?
Bottom line: There can be a time and a place for both types of payments. However, make sure that you understand all of the costs as well as what’s in it for the advisor and their firm. Long-term outcomes can be significantly impacted by cost and advice. And finally, do you have absolute confidence that your advisor’s interests are 100 percent aligned with yours? If you have any doubts, don’t wait another day. Make a change now.