When we adopted the fee-only model in 2005, we were "out in front" of the industry. In its original state, the fee-only model meant:
- Always acting as a Fiduciary.
- Compensation solely from client fees and no other sources.
Our philosophy is simple: if our sole source of income is our clients, then our loyalty lies solely with them.
Since we became registered as investment advisers, a variant of the business model has come to the forefront called the "fee-based advisory model". In this process, what was once black-and-white has become many shades of gray.
What is the difference between "fee-only" and "fee-based"?
A "fee-only" Registered Investment Adviser is paid strictly from client fees and does not receive any sort of compensation from the custodian or any other third party. This is how we are set up. A "fee-based" financial advisor will have two securities-based licenses—one to carry out brokerage transactions for a commission and one to conduct fee-based business. And, oftentimes, there is nothing wrong with this arrangement unless your answer to the following question is "YES". Does your financial professional custody commission business and fee-based business with the same broker?
Why is this such a big deal?
1. I can almost guarantee your financial professional is violating his Fiduciary duty by placing both types of business within the same brokerage firm. A significant part of the Fiduciary role is to recommend a custodian that is in the client's best interest. Most fee-only advisers will use Fidelity, Schwab, TD Ameritrade, or our custodian Interactive Brokers. I can confidently say that these firms offer a better solution for you than any fee-based custodians like Edward Jones, Merrill Lynch, LPL Financial, and Wells Fargo. By recommending or requiring a client to have their fee-based account at one of the latter groups, the advisor is disregarding his fiduciary duty.
2. It is impossible to delineate where an advisor's compensation is generated from when his business is entirely under one roof. For example, when I was recruited by a large wirehouse with a fee-based program, they outlined an explicit asset-based bonus that was applied across both fee and commission accounts (i.e., the bigger my fee book was, the higher my payout would be on my commission book). This is an overt conflict of interest and in direct violation of the fiduciary standard. Still, large firms get away with these types of arrangements because of their political and regulatory connections.
3. No matter how "independent" your advisor's platform is, the custodian will steer business to fit their profit model. Even when I was on Fidelity Investments' fee-only platform and had no financial arrangement with them, they continuously sought to steer business into their funds. I know many independent brokers that charge excess fees for holding "off-platform" accounts and/or prohibit off-platform fee business if certain minimums are not met.
In nearly all cases, if the financial professional is conducting both fee and commission business with the same firm, conflicts exist and a true fiduciary arrangement is not in place. It is a clear red flag and testifies to the fact that the client's needs will rarely be a first priority.
How can I tell if my financial professional is fee-only or fee-based?
First, you can ask your advisor if they custody both types of accounts (fee and commission) at the same firm. If the answer is "yes", then they are conflicted.
Second, if their business card or website has this verbiage: "Securities offered through...", then they are conflicted.