Understanding the fee structure of your financial advisor is a key step to ensuring your financial interests are being met. It’s important to note that financial advisors operate under various fee structures, including fee-only and commission-based, and each structure offers different incentives to advisors and to clients. Having a firm grasp on your financial advisor’s method of compensation helps you understand the full picture of how your investments are being managed.
There are two primary ways financial advisors make money: via fee-only and commission-based approaches. Both methods allow advisors to offer financial advice and investment services for their clients. The difference is in how the advisor and the firm earn income from these services.
Fiduciary and Suitability Rules
To understand the difference between compensation approaches, let’s first examine the difference between fiduciary standards and suitability rules. Fiduciary standards are the highest level of accountability required from financial advisors and brokers. These standards require recommendations to be in the best interest of a client, even if that means loss in profits for the advisor. For this reason, fiduciary standards are typically held in high regard by investors.
Suitability rules are a more lenient standard of financial advice for brokers and advisors. Suitability requires products or services to be ‘suitable to the client’s needs.’ While this sounds like reasonably protective language, and it is, it also allows for advisors to push clients towards particular financial products to earn more commissions. As long as the broker can prove the product or service is ‘suitable’ for the client then it’s legally acceptable; even if the product may not be the best product or service available for the client.
Interestingly, earlier this year, the Department of Labor passed a new fiduciary rule requiring all brokers and financial advisors to abide by stringent fiduciary standards for clients, in other words to require firms to act in client’s best interest. The ruling has seen push back by major financial corporations with business model’s created around commission-based and suitability standards. The regulation is scheduled to take effect April 10, 2017. However, President-elect Trump and the Republican-majority Congress may repeal the new standard citing evidence the ruling will increase advising fees which may mean only high-income clients will quality for services.
Commission-based financial advisors and brokers earn a commission for every sale or trade of a specific product or service. These types of advisors usually earn commission at the opening of an account and therefore are incentivized to push clients towards specific products and services. Advisors under commission-based payment structures may tend to focus on a client portfolio, with less attention being paid to other areas like financial, tax, estate, and retirement planning. Commission-based advisors may follow fiduciary rules or suitability standards, depending on regulations set out by their firms.
Fee-only, like it’s name, is a fee-based approach with a fiduciary responsibility to act in their client’s best interest. These advisors do not receive compensation from selling certain products or services to clients. Instead fee-only advisors are paid via flat fees, retainer fees, and/or by percentage of managed assets. Because this fee structure is not incentivized by selling specific products or service packages, it’s generally believed that fee-only advisors have less conflicts of interest and are able to offer clients more comprehensive and personalized financial advice. This type of approach also tends to take a more holistic approach, looking at all areas of a client’s financial portfolio, in a way commission-based does not.
At Idaho Medical Association Financial Services (IMAFS), we operate on a strictly fee-only basis. We believe in creating a transparent environment for our clients; one where clients know the fee structure ahead of time and where clients understand how and why their portfolio is being managed like it is. We’re not limited to pitching specific products or services across our client roster. Instead, using a fee-only structure allows our financial advisors to create individualized plans that meet specific financial goals while considering all areas of investment opportunities like financial, tax, estate, and retirement planning.
Idaho Medical Association Financial Services is a financial and wealth management firm specializing in personalized financial guidance to accredited investors in the medical field. Areas of speciality range from investment planning and retirement analysis to in-depth services such as tax analysis and strategies, insurance and estate planning and financial planning. For a free financial consultation, please call: (208) 336-9066 or email firstname.lastname@example.org.