The Benefits of Working with a Fee-Only Adviser
When starting out on the path of selecting an investment adviser it is important to understand how they are compensated in order to determine their motivation for investing your hard earned nest egg. Often times advisers have selected, either intentionally or inadvertently, a compensation arrangement that creates a conflict of interest with their fiduciary responsibility to you, the client.
There are many different types of compensation arrangements with pros and cons for each. The most common are: commission based, fee-only, wrap fees, and flat or hourly fees. For the purposes of this article I am going to focus primarily on fee-only vs. commission based advisers because they tend to be the most common in the industry.
A commission based adviser is paid by the broker or investment company when they place you in a mutual fund, REIT, annuity, life insurance policy, or similar sales loaded product. Each of these investments typically pay a trailing fee to the adviser so that they are earning money as long as they keep you fully invested. In addition, they can even collect a portion of the trading fees for stocks, bonds, or ETF’s in your account.
A commission based adviser doesn’t charge a regular ongoing fee to manage your portfolio. Instead they are financially motivated to keep you invested at all times in the products that pay them the most money, rather than investments that may be best suited to meet your goals. This creates a glaring conflict of interest that can be avoided by selecting a fee-only investment adviser.
A fee-only investment adviser charges an ongoing management fee (usually monthly or quarterly) to select the best investments to meet your goals rather than being beholden to the highest commission products. The fee is typically expressed as a percentage of assets under management so that when your account grows, so does the advisers compensation. This removes the conflict of interest and puts both the adviser and the client on the same side of the table.
A fee-only investment adviser that actively manages your portfolio should put you in the lowest cost investments to give you the best returns, net of fees. They are also held to the highest standard of fiduciary conduct which means that they must place your interests ahead of their own at all times.
It should be noted that there are advisers that charge both commissions and management fees which are very expensive to the client. You should thoroughly research and ask questions before you start a relationship with any adviser to understand their investment philosophy, compensation, track record, and experience.
Here are 10 questions to ask your adviser to determine if they are best suited for you:
- How are you paid for your services?
- What types of investments do you recommend and what are their expenses?
- What is your investment philosophy and how do you implement it?
- What brokerage firm do you use and what are their fees?
- Do you receive any compensation directly from the investments you recommend?
- Are there any surrender penalties for the investments you recommend?
- Do you actively manage your portfolios or simply rebalance them on a predetermined schedule?
- How did your recommendations perform during the last Bear Market?
- Do you use stop losses or a sell discipline for your recommendations?
- What is your current outlook on the market and what strategies will you implement if conditions change?