Choosing a financial advisor is a deeply personal and potentially life-altering decision. It’s important to partner with someone you connect with, a professional dedicated to putting your best interest first. Their skills, experience and ethics must align with your values, goals and dreams. Like any thriving relationship, a level of connectivity, respect and trust must be foundational. But did you know it’s equally important to understand how your wealth manager is compensated?
Depending on their business model, financial planners can be paid in three ways:
- Commission-based: Some advisors are compensated strictly on commissions. This means they earn money when they sell investment products and conduct transactions on your behalf. Since a planner’s income is tied solely to the products they recommend and sell, this model has potential to create conflict of interests.
- Fee-based: This hybrid method combines elements of both fee-only and commission-based compensation. Advisors may charge for financial planning services while simultaneously earning commissions on the sale of certain products. It’s crucial to understand whether the advisors’ recommendations truly prioritize your best interests.
- Fee-only: Since the fee-only model is rooted in the concept of fiduciary duty, advisors following this model are legally and ethically bound to act in their client’s best interest. When working with a fee-only advisor, you can trust the advice and recommendations to be unbiased and genuine, without any hidden motives. To minimize conflict and provide the utmost transparency, the National Association of Personal Financial Advisors (NAPFA) recommends investors only utilize the services of fee-only fiduciaries.
To further explain the differences, imagine that you are booking a trip and getting a little help from three travel agent friends, John, Paul and George (sorry Ringo!). This example of planning a vacation using the services of three different agents with very different business models mirrors the world of financial advisors.
- Commission-based: John offers his services for free, but he earns his income through commissions from recommended hotels, airlines and tour companies. While he may very well provide valuable guidance, we can’t ignore the fact that his financial motivation might steer his clients toward options that pad his wallet, regardless of their best interests.
- Fee-based: Fee-based travel agent Paul charges his clients for his services. Like John, he is also compensated for the products or services he recommends. This combination of fees and commissions introduces the same conflicts of interests, leaving you wondering if his recommendations are truly in your best interest or if they’re influenced by the commission he stands to gain.
- Fee-only: Finally, we meet with George, the fee-only vacation planner. Similar to Paul, George charges a predetermined rate for services. But here’s the game-changer: George does not accept any commissions from the companies or products he recommends. With no financial incentive to sway his judgement, George is dedicated to providing the best possible service and personalized advice based on each client’s unique needs.
Since fee-only fiduciaries have a legal and ethical obligation to manage your money objectively and with the highest standard of integrity, trust and confidence, you can be sure your long-term interest will be prioritized over profits. They are called to consider a client’s personal and financial goals to create impactful, cost-effective solutions while keeping performance top of mind.
This business model ensures planners focus on what truly matters – your financial well-being. Free from the pressures of chasing commissions, they can dedicate more time to critical aspects of financial planning such as detailed tax planning, fine-tuning estate documents and insurance policies, designing tax-efficient gifting and cash flow strategies and much more.
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