The financial services industry has a bad habit of using terms that can seem vague and confusing to clients. There is probably no place where this confusion is greater than how an advisor is compensated. Additionally, the term fiduciary is tossed around by the media quite a bit.
However many investors don’t fully understand what a fiduciary is and why it's important to work with a financial advisor who acts in a fiduciary role to their clients.
While this sounds like a simple question with a straightforward answer, oftentimes it isn’t quite so simple. Let’s look at the three main ways in which a financial advisor might be compensated for working with you as a client.
Commissions represent payments for selling investment and insurance products to their clients. The commission is paid to the advisor’s firm by the insurance company or the investment company offering the product.
The level of commission on a financial product might be an incentive for the financial advisor to suggest that product to a client versus one that might be more appropriate for their needs. Commissions might also take the form of various trailing fees on mutual funds or other types of fees paid to the advisor over time.
Fee-based is perhaps the most confusing type of arrangement to many clients. Fee-based is often a combination of some sort of fee for a financial plan combined with the implementation of some or all of the planning recommendations via commission-based products.
Fee-based is often confused with fee-only which has gained increased popularity based on the publicity that fiduciary advisors have received in recent years. We suspect that this confusion may be intentional in some cases.
Another take on the fee-based model is a push by many brokerage firms and broker-dealers in recent years to offer brokerage wrap accounts. These are managed accounts for which a management fee that is usually based on a percentage of assets is charged.
Additionally, the underlying investments are often mutual funds that offer compensation to the brokerage firm in the form of fees such as 12b-1 fees or similar fees. This aspect can make the underlying funds more expensive for the investors and more lucrative for the brokerage firm offering the wrap account.
Fee-only is largely what it sounds like. The financial advisor is compensated only from the fees charged to their client. There is no compensation from the providers of financial products.
Fee-only compensation might be an hourly arrangement, it might be a flat retainer fee, or it might be charged as a percentage of the client’s assets under advisement. Clients pay the advisor only for the advice they receive. At Canty Financial we are fee-only financial advisors.
How your financial advisor is paid is a critical question as it goes to whether or not their advice to you is based on suggestions and recommendations that are predicated solely on what is best for you as their client, versus whether their advice is influenced by the utilization of financial products that offer them the highest levels of compensation.
Before hiring any financial advisor you should insist on knowing all forms of compensation that the advisor will receive from working with you.
If an advisor won’t readily disclose this information to you, this should raise a red flag and cause you to question whether this is the best advisor to work with.
The term fiduciary applies to someone legally acting on behalf of another person or a group to manage their assets. An attorney, a trustee or a financial advisor can all be examples of someone acting in a fiduciary capacity.
A financial advisor who acts in a fiduciary capacity pledges to put the interests of their clients first. This means that any recommendations made to their clients are made solely with the client’s best interests in mind. This includes any financial products that are recommended or any other suggestions they might make to you.
People are often surprised that a financial advisor is not obligated to work in the best interests of their clients. For years the brokerage world worked on the suitability standard, this means that a recommendation for a financial product must be suitable for someone in a similar situation to their client but doesn’t necessarily have to be in their best interests.
The recent enactment of Reg BI disclosures for broker-dealers establishes a standard of conduct for brokers in terms of recommending only those products that are in their client’s best interests and requiring disclosures of any conflicts of interest. This is a positive step but falls short of requiring these brokers act in a fiduciary capacity.
A financial advisor does not have to use the fee-only compensation model to be a fiduciary, but it's pretty hard to see how an advisor who is compensated via commissions can truly act in a fiduciary capacity.
If an advisor who you work with or with whom you are considering working says they act in a fiduciary capacity ask them to put this in writing.
The combination of an advisor who is a fiduciary and who works on a fee-only basis is a powerful one. We are clearly biased, but we feel that this arrangement is generally best for a client.
In our opinion, financial advisors should be compensated for their advice and expertise, not for recommending one provider’s financial product over another.
We feel adamant that no client should ever be confused by how their financial advisor is compensated, nor should they ever have to question whether or not their financial advisor has their best interests in mind.
If you are looking for a fee-only fiduciary financial advisor who will always put your interest first, please give us a call.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor