Choosing a Financial Advisor, Part 2

“A Fee-Only financial advisor charges clients directly for his or her advice and/or ongoing management. No other financial reward is provided, directly or indirectly, by any other institution. Fee-Only financial advisors are selling only one thing: their knowledge.” – National Association of Personal Financial Advisors.

In a previous post, I wrote that a fee-only financial planner might be better choice for you than a financial planner who is compensated by commissions. Here is a continuation of an article by the Consumer Federation of America, an advocacy, research, education, and service organization.

The Financial Planning “Name Game”

If a fee-only financial planner is probably your best bet, what about all those other planners out there? As consumers have started to wake up to the conflicts of interest that result from commission-based compensation, more and more financial planners have adopted confusing terminology designed to obscure how they are compensated. Here are a few of the most common that you should be on the look-out for:

Fee-and-commission. This is the now somewhat out of fashion term for a planner who earns a fee for developing a financial plan, then earns commissions selling the products to implement that plan. For years, planners were able to sell this arrangement as being in their client’s best interests on the grounds that they were more objective than commission-only salespeople and more affordable and convenient than fee-only planners.

Since consumers have become more conscious of the total costs of fee-and-commission planning and the incentives commission-dependent planners have to steer them into costly and possibly inappropriate products, few planners now use this relatively candid terminology, though the majority continue to practice in this fashion.

Fee-based. This is today’s more fashionable terminology for fee-and-commission financial planning. The conflicts are the same, but the candor is gone. Some “fee-based” financial planners will tell clients they can work either on a fee-only basis or on a fee-and-commission basis if the client wants to implement the plan through them. Somehow, however, the bulk of their clients end up as fee-and-commission clients. The term “fee-based” is misleading, so you should be wary of those who use it.

Fee-offset. Under a fee-offset arrangement, a planner imposes a fee for drawing up a strategy, then reduces up to 100 percent of that fee to account for any commissions that may be earned in implementing the plan. The problem of commission bias is less obvious, but it remains. After all, if a financial plan costs $2,000 and the planner earns $10,000 in commissions for selling the needed products, he or she will be able to pocket $8,000 in conflict-producing commissions …even after totally offsetting the cost of the original plan.”

Interpretation

How your financial advisor is compensated should be important to you, because being paid a commission results in the (very distinct) possibility of a conflict of interest. Fee-only means the advisor cannot accept commissions. If the financial advisor’s paycheck comes from a brokerage firm, then the advisor is an employee and owes loyalty to the firm. When the paycheck comes directly from you, your interests come first.

As many consumers have discovered, some brokers regularly rely on obfuscation – confusing them with dozens of “facts,” figures and recommendations until their head is reeling. It’s disingenuous for them to suggest that you are not paying a fee, because the mutual fund (or insurance company) pays it. Certainly, no one would assume that the fees come from the benevolent tooth fairy. I call it obfuscation, but that’s really just a polite way of saying that they’re lying to you.

What you really need is someone who will put your financial interests first. This is a good description of someone who acts as a fiduciary.

Since labels for advisors – fee-based, fee-offset – are often confusing (on purpose, in my opinion) your best defense is to ask very pointed questions and expect very direct answers.

Question #1
You: “How are you compensated?”
Advisor: “I am compensated solely by my clients.” Correct answer.
Advisor: “Oh, you needn’t worry about that! My fees get paid by the insurance company or mutual fund.” Incorrect answer.

Question #2
You: “Do you act as a fiduciary?”
Advisor: “I always act as a fiduciary.” Correct answer.
Advisor: “Sometimes.” Incorrect answer.

Question #3
You: “Will you put that in writing?”
Advisor: “Yes, I will put that in writing.” Correct answer.
Advisor: “My word is my bond.” Incorrect answer.

You should be aware that members of the National Association of Personal Financial Advisors sign a Fiduciary Oath.

I actually give my Fiduciary Oath to prospective clients at the first meeting along with the Privacy Notice.

To be continued.

photo credit: emuphoto