The Double F in Fees. 

If you read our last blog you are somewhat familiar with the different ways financial advisors make money ie-collect fees.  We will go into a bit more detail on each way an advisor can make money.  

Transparency is very important.   You should know what you are paying your financial advisor and how you’re doing so.  

When you start to look at the ways advisors get paid you’ll notice there are commissions, fee-based, and fee-only.  Before we jump into the nitty gritty around compensation, let’s get a few common terms defined for you-assets under management,  conflicts of interest, and fiduciary.

Let’s start with assets under management (AUM).  This means the fee that is being charged, is for the assets (accounts) that the financial advisor is managing the investments on.  An example of this would be if you set up an IRA with this financial advisor and they are deciding on the investments inside this IRA, then most likely this account would be included in the fee for assets under management.  Now, let’s say you have a 401(k) and the financial advisor is NOT managing those assets, then this account would most likely not be included in the fee for assets under management (always confirm this is the case). 

Conflicts of interest are well, pretty straightforward, or are they?  A conflict of interest is a situation where the advisor’s personal interest could compromise their judgment, decision, or opinions on a client’s situation.  You get it? We agree this one definitely needs a few examples.  Let’s say a financial advisor gets paid $5 for using XYZ companies’ annuities and gets paid $10 for using ABC companies’ annuities.  Well this creates a conflict of interest as it could create a situation where the advisor doesn’t share XYZ annuity with the client because they will get paid more for the ABC annuity.  This does not mean that the higher commissioned product is bad,, it just means that the advisor should disclose this conflict of interest and share information on both annuities and let you, the client, decide. 

Let’s go through one more example to really make this clear as mud!  Investment advice could be a conflict of interest.  Let’s say a financial advisor is managing your investments and uses all RST funds because they pay a commission to the advisor.  Again, does not mean that RST funds are bad, it just means that the advisor should be disclosing this conflict of interest with an explanation on why they use these funds.  

Fiduciary-you hear it often; however, do you really know what it means?  A financial advisor who is a fiduciary is legally obligated to act in the best interest of their client at all times.  Another way to put this is that your interests (the client) are ahead of the financial advisors interest.  Fiduciary Financial Advisors have a duty of care and duty of loyalty to you, the client. Duty of care means the advisor takes in consideration all aspects of your (the client) situation before making recommendations.  Duty of loyalty means the advisor acts as a fiduciary at all times of engagement with the client and to disclose any conflicts of interest that may arise.  

Ok, now that you are a guru with understanding AUM, conflicts of interest and fiduciary, let’s move on to the Double F in fees. Fee-Based and Fee-Only.

What are the differences? 

            Fee-Based are typically financial advisors who charge fees for their services, and who may also earn commissions or other forms of compensation from the sale of products to clients.  Commissions can be on investment products (ie. mutual funds), or financial products such as annuity or life insurance contracts.  These commissions are paid by third parties, such as institutions or product providers.  

            This is not necessarily wrong or bad; however, it is something you as the client should be aware of.  Why?  Because it can cause some conflicts of interest between you, the client, and the advisor.  It’s best to ask the advisor to disclose all conflicts of interest so you can understand what conflicts arise by being their client.  An example is if you are working with an advisor who recommends an annuity product and only presents an annuity product from one company.  This could be a case where they are beholden to the product company and therefore cannot recommend outside product providers which may have better products to suit your needs.

            Fee-Only are typically financial advisors who are compensated only by the fees they charge their clients for their service.  These fees can be charged in different ways.  For example you could be charged hourly, a flat rate, or a percentage of the assets the advisor manages (AUM).  Essentially any of these fees are paid directly by you, the client, to the advisor.  The advisor does not earn any commission or any other form of compensation from any financial institutions or product providers.  

This tends to reduce the amount of potential conflicts of interest because the advisor has no incentive to recommend certain products over others based on the commission they would earn from that product.  It also creates transparency as you, the client, knows exactly how much you are paying for the service you are receiving.  Typically, you will find this type of arrangement aligns well with the client’s best interests as their compensation structure is not tied to specific financial products. 

The other compensation model to understand is commission based. 

            Commission based compensation means that the advisor is going to be compensated with a commission on the product or investment they sell.  An example would be an insurance policy.  Let’s say you purchase a life insurance policy from a financial advisor who is not fee-only.  The financial advisor is most likely earning a percentage for the sale of this product.  You, the client, do not pay this out of pocket, the insurance company pays the financial advisor.  Another example could be investment related.  The advisor sells you a certain mutual fund and earns a percentage of that sale. 

To be completely honest no fee structure is perfect in our opinion.  What matters the most is that your financial advisor is a fiduciary at all times, that you understand how you are paying them for their advice, and any conflicts of interest are disclosed.  Once you have all of this information you can make an informed decision on if that aligns with your needs.   

Check out the diagram below for an easy to digest breakdown of Fee-Only & Fee-Based.  As always, reach out with any questions and don’t let the world of fees overwhelm you. 

The 4 Things to Know When Searching for YOUR Financial Advisor!

So you are looking for a financial advisor and come to a worldwind of acronyms and confusing titles?  We will try to break down all the buzz words to help you get a better grip on what to look for. 

  1. Financial Advisor/Wealth Advisor/Financial Consultant/Financial Professional–what are the differences?  

            It’s a little complicated since there are no regulations on who can use the above titles and in our opinion it’s one downside to our industry and can get very confusing when you are searching for someone to help you with your finances.  There tend to be trends on who uses what title; however, it definitely is not a good indicator on what they provide or what distinguishes them from another advisor.    You will want to do a little digging to find out what type of licenses and designations the person has.  The biggest thing you’ll want to determine is if the advisor is really going to help with full comprehensive financial planning, or are they going to sell you a product-whether it be insurance or investment-, or are they only managing investments ie. asset collectors.  Neither of these is necessarily bad; it’s just you wouldn’t want to go to an asset collector if you are looking for someone to help guide on social security strategies.  Or you wouldn’t want to go to an insurance salesperson if you are looking for investment advice.  

  1. This is the lowdown on designations that make an advisor stand out from another.  The designations below make a big difference, at least in our book.

Certified Financial Planner® (CFP®)-this is one of the more comprehensive designations for individuals in personal financial planning.  The designation coursework and continuing education covers a robust list of topics-insurance (both property & casualty, and personal), investing, taxes, estate planning, and retirement.  

Enrolled Agent (EA) or Certified Public Accountant (CPA)-advisors or planners who acquire these designations are ones who hold tax as an important topic for clients.  They are going to be experts in accounting and tax issues.  Some could offer tax preparation services as well.  A CPA is going to be the superhero of the accounting world.  They’ve gone through real rigorous training, have passed some pretty tough exams, and are licensed to handle a whole bunch of accounting matters.  Most are going to be all-around experts in accounting, tax preparation, audit, and maybe even consulting.  An EA might not be the superhero of the accounting and tax world; they are more like the ninja of taxes.  They really focus on tax matters and are enrolled to represent taxpayers before the Internal Revenue Service.  They go through some rigorous training and pass some tough exams as well.  EAs can prepare tax returns, offer tax planning advice, and represent clients in front of the IRS.  Both are awesome in their own rights, and can tackle different aspects of the financial tax world. 

Chartered Financial Analyst® (CFA®)-this one is definitely considered to be one of the most difficult designations to acquire.  It really focuses on investments and portfolio design.  

Fiduciary-the buzz word that keeps on buzzing!

            This is like the advisor titles, it’s used more often than not and is not regulated.  Essentially what this breaks down to is if you are acting as a Fiduciary you are legally obligated to put your clients’ interests before your own.  Ie-work in the interest of your client, not yourself.  Typically you would have seen this with advisors that charge a fee to manage their clients investments in which they would put their clients investment interests ahead of their own.  Now you are seeing this commonly used with commissioned (sales) advisors.  We are not here to judge; however, we find it hard to understand how it’s possible to put your clients’ interest first when you have products with some being the more costly ones providing the highest commissions.  Again, not always wrong, just an opinion.  It can be advantageous to confirm a few things from your fiduciary advisor.  Are they acting as a fiduciary 100% of the time, or does the advisor sometimes fall under the suitability standard? The suitability standard requires the advisor to recommend investments or products that are suitable for their client at the time of sale.  Also ask are they earning a commission for any of their product sales?  Again, not necessarily a bad thing; however, you need to know prior to making a decision.  Asking this question leads us to our next topic-fees- how fun!

  1. How are advisors paid? 

Fee-Only

            This means that a client is paying the advisor for the advice that they give.  The advisor is not collecting commissions or fees from the types of investments they offer.  In our book, this provides the least amount of conflicts of interests between client and advisor.  We have seen this term used incorrectly, so make sure to confirm that the advisor is not also earning commissions.  

Fee-Based

This can be misleading and you will need to ask follow up questions.  Most likely the advisor is charging a fee for the assets they manage; however, they can also earn commissions, awards for selling specific products, bonuses for hitting sales targets, etc.  Again, not necessarily a bad thing; however, it could lead to a few conflicts of interest.  Make sure to ask the advisor on all the ways they get paid and explanation on what types of conflicts of interest exist.  

Commissions

Essentially, similar to fee based.  You earn a commission on a product you sell whether it be an insurance or investment product.  Some examples could be life insurance, annuities, mutual funds, etc.

*if you haven’t yet, check out our blog on “The Double F in Fees” for a more detailed explanation.  

  1. What are the services provided-the value to you?

Comprehensive Financial Planning

      This is a holistic approach to planning and it means that the advisor will utilize the following topics to create and maintain your financial plan- your financial goals, risk management (insurance planning), investment planning, tax planning, retirement planning, savings/debt (cash flow) planning, and estate planning.  You are going to get the most value out of comprehensive planning as each topic will play into another topic.  You wouldn’t want to set financial goals and then have your investment planning going in a completely different direction.  Usually when you are working with an advisor who is doing comprehensive financial planning you are touching on all of these topics throughout the year; however, it could be a situation where no big life changes are happening and your retirement plan for example doesn’t need big updates.  

Investment Management Only

     This is when an advisor is only offering advice around investments.  Usually you’ll see your advisor once a year and the conversation will mainly focus on your investment planning.  You may touch on other topics but you don’t typically dive deep into how each topic coordinates with the other.  

Designations, fees, and what the advisor’s services are all very important factors; however, another big one is someone you feel comfortable with.  If you are dreading meeting your financial advisor at any point, that is a red flag.  You should be excited to see them and feel a sense of relief after your meetings-at least that’s what our clients say!