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Advisers: Explaining Fee-Only Compensation

Financial advisers whose compensation method is fee-only need to be able to explain how this works and why it is advantageous to their clients

The financial services industry uses many terms that are confusing to clients. One such term is fee-only compensation. This is easily confused with fee-based compensation. With the spotlight recently shining on the issue of being a fiduciary, advisers whose compensation method is fee-only should be prepared to explain how this works and why it is advantageous to their clients and prospects.

Fee-only compensation means that the financial adviser is compensated only by fees they charge for the advice they provide. This might be in the form of a percentage of the assets a client has under advisement with their adviser (AUM), an hourly rate, a project fee (for a financial plan as an example) or a flat ongoing retainer.

It is important to stress to clients and prospects that this means that you are not compensated based on the sale of any financial product. This eliminates a key potential conflict of interest -- that being that your advice to them might be influenced by the compensation you would receive from selling a particular product.

Fee-Only vs. Fee-Based

Fee-based is often confused with fee-only. This seemed to be the case even more so in recent years with the passage of the fiduciary rules under the Obama administration that have been largely repealed under the Trump administration.

Many brokers and financial advisers touted their fee-based offerings such as wrap accounts and similar offerings. This has served to cause a lot of confusion among both clients and prospects.

Discussing the difference between fee-based and fee-only advice is important for your clients and prospects because this can be a way to differentiate yourself as a financial adviser. Stress that fee-based can include an arrangement where the adviser does some initial work for a fee, perhaps an initial financial plan. But beyond that, if the client chooses to implement the plan with that adviser, there are often commissions or other types of compensation that the adviser receives from the financial products used to implement the client’s plan.

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This might be commissions from insurance products, including annuities. Or it might be via the use of a wrap account for the client’s investments. Often these accounts include mutual funds or similar products that throw off revenue sharing to the financial adviser.

A good analogy for clients and prospects is going to eat at a restaurant. We’ve all had the experience of asking a waiter or waitress their opinion about one or more dishes on the menu. They will generally tell you what they think and oftentimes preface their opinion with the fact that they like or dislike certain foods. What if this member of the wait staff was being paid a fee by the restaurant’s provider of chicken based on the volume of chicken used? Would you feel as comfortable that their comments were honest or tainted by the opportunity to make some extra money by only recommending the chicken dishes on the menu?

Why Fee-Only Is Advantageous

In touting the benefits of working with a fee-only adviser, some things to point out to clients and prospects include:

  • Fees are clear and transparent under this arrangement. There are no hidden fees or commissions as with some other types of fee arrangements.
  • They are paying only for the services and the expertise of the adviser.
  • This type of compensation arrangement eliminates a major potential conflict of interest that advisers who are paid all or in part via commissions might have that could taint the recommendations that they make to their clients.

Part of the Overall Picture

As a financial adviser selling yourself to prospects and reinforcing your value to your clients, stressing the advantages of working with a fee-only adviser makes sense.

As you know and as you would likely stress to clients and prospects, an adviser’s compensation structure is only part of the picture that they should be considering. The adviser’s credentials and training should be considered. Likewise with the adviser’s experience and the types of services they offer. Are these a match with the needs of the client or prospect?

If you are a fee-only adviser, you likely chose this route in part due to your commitment to wanting to provide a strong value proposition to your clients. We aren’t saying that advisers who are compensated in other ways don’t have this commitment. But in the current environment of clients seeking transparency in their relationship with a financial adviser, if you are a fee-only adviser this can be a major selling point in your favor to your clients and prospects.