Matt ran across an interesting statistic recently, that only about five percent of financial advisors operate on a fee-only basis. This is not an official SEC or FINRA statistic, but it does highlight something important about the industry of financial advice. Most advisors are getting paid fees for assets under management and commissions from selling certain products like mutual funds, annuities, or insurance policies. While there is nothing inherently wrong with this business model, it does create different incentives for the advisor, and that is what Matt focuses on in this episode.
Broadly speaking, there are two ways that advisors get paid. "Fee-based" advisors charge a fee for the money they manage, usually a small annual percentage. This fee is paid by the client. They may also collect commissions from investing a client in certain investment products. Commissions are paid by the companies selling the financial products. "Fee-only" advisors, on the other hand, charge a fee for their planning and advice services, and may charge a fee for the assets under management. They do not receive kickbacks or compensation for steering their clients toward certain investments.
Then there's the term fiduciary, which does not describe compensation but the responsibility an advisor has to his client. A fiduciary is legally bound to always act in the best interest of their client, regardless of which investment products they choose.
It's not hard to see that commission based advisors have an incentive to push certain products. They may be good products, or may not, but the incentive to sell them is there, and it's important to be aware of, especially given that the majority of the industry is still compensated in this way. Fee-only fiduciaries also have incentives -- they make more money if you invest more money with them, versus using your money to pay off debt, for instance -- so it's not about making a moral judgment of which business model is right. It's about understanding what the incentives are, so that you know where the biases of your advisor lies, and how you can choose the best advisor for your needs.
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14 mins