What Is Fee-Only Financial Planning?
Fee-only refers to a business model for financial advisors in which their sole source of income is fees from clients. Alternatives to this model are commission-based models and models in which advisors earn income by using a combination of client fees and product commissions. Fee-only models require that financial advisors invest in their client’s best interests and do not consider product commissions while making recommendations. The advantage of hiring fee-only financial advisors is that they are required by law to act in your best interests. This also means that any potential investment plan proposed by your advisor will be customized to your circumstances and financial situation. Fee-only financial advisors are also required to disclose their billing methodology and potential conflicts of interest before beginning consultation. Such transparency can engender trust between an advisor and client. The disadvantages of using fee-only investment advisors are that they can be expensive and time-consuming. Fee-only services may also have fewer products available in the investment portfolio.
Financial advisors have three business models to earn income:
- Commission-based model: In this model, advisors earn income based on commissions for products they sell to clients. For example, an ETF provider may pay a certain amount of money as marketing fees to advisors to include their product in client portfolios.
- Fee-based model: In this model, advisors do not sell investing products. They charge clients a flat rate or by the hour for their services. In some instances, they might also charge fees that are equal to a percentage of the assets under management with the advisor.
- Fee plus commission model: As the name indicates, this model is a combination of fee from clients plus commission charges from vendors of investment products.
The first and third type of business models set up potentials for conflict of business interests. For example, a financial advisor may recommend an investing product because it provides a higher commission. They may do this irrespective of the fact that it is not a good fit with the client’s portfolio goals. All fee-only financial advisors are required to follow fiduciary duty, as defined in the Investment Advisers Act of 1940. The duty comprises duty of care and duty of loyalty. The former requires financial advisors to provide investment advice in the best interests of a client and the latter requires them to eliminate or make full and fair disclosure of all conflicts of interest. Those financial advisors who are not fee only or have chosen not to be fiduciaries are only held to the suitability standard i.e., they are only required to recommend products that they consider suitable for an investor’s portfolio.
How to Evaluate Your Fee-Only Financial Advisor
A complete disclosure of the financial advisor’s conflicts of interests and fee policies can be viewed on the adviserinfo.sec.gov website. The site contains registration and reporting details that financial advisors are required to file with the agency before setting up shop for clients. The ADV form provides comprehensive information about the advisor’s business, including description of services offered, explanation of fees, billing practices, and past criminal history, if any. Specific information within the form is designed to alert clients about details relating to the financial advisor’s dealings with the ecosystem that they operate in. There are three parts to the form. The first part provides ownership information about the advisory firm. Part II asks the applicant to create a narrative brochure with information about the firm. They are also required to provide brochure supplements pertaining to their business in this part. The final part consists of a relationship summary in which the advisor discloses their relationships with investment firms, fees received from these and other companies, and potential conflicts of interest in their business. Thorough evaluation of the ADV form can reveal relationships between advisors and related parties. For example, in an earlier case, a Florida-based financial advisor was found to have an improper relationship with an commissions-based insurance agency, that they also owned. For a step-by-step guide on using Form ADV to determine if a financial advisor is fee only, check our article on How to Tell if Financial Advisor is Fee-Only.
How Much Do Fee-Only Financial Advisors Cost?
Since the only source of income for fee-only financial advisors is client charges, it might be interesting to take a look at how expensive they are. Surveys have come up with different estimates of charges associated with financial advisors. For example, a 2020 survey conducted by Kitces, a website for financial advisors, found that financial advisors charged an average of $250 per hour. Advisors who were not certified financial planners (CFPs) charged less, around $225 to $200 per hour, as compared to those who had the desired qualifications. The fees increased substantially for those advisors charging their clients based on the number of assets under management. The survey found that hourly fees for advisors charging on an AUM basis was between $350 and $800. The median fee for retaining the services of a financial planner was $4,000 and the median fee to craft a one-time financial plan was $2,500. In addition to providing estimates, such surveys also shed light on the pros and cons of billing methodologies used by financial advisors. For example, advisors who charge based on AUM are more expensive as compared to those that don’t. But the former might work out to be cheaper for individuals who have substantial assets because a billing structure based on AUM, in such instances, may require more hourly effort and inflate the overall cost.
Advantages and Disadvantages of Fee-Only Financial Advisors
The advantages of working with fee-only financial advisors to craft a financial plan are as follows:
- Fee-only financial advisors are motivated by their client’s best interests. They are bound as fiduciaries to provide you with the best available investment options available in the market and to craft a plan that matches your financial goals. A financial advisor who works on a commission-based model may not always have your best interests at heart and may only be interested in maximizing their revenue.
- Fee-only financial advisors are required by law to be transparent about their dealings with investment firms. This transparency, documented in the ADV form, can help you evaluate their standing and potential conflicts of interest.
- Fee-only financial advisors have varying fee structures that provide flexibility based on your consultation needs. While the hourly rate structure can be expensive (see below), it can also work out to a cheaper advantage because you can restrict your consultation period costs, if you already possess knowledge about a specific investment. Since a financial advisor is required to provide you with an honest opinion, that consultation may be worth more than one with an advisor who may be receiving commission from the makers of that product.
Some of the disadvantages of fee-only financial advisors are as follows:
- They are more expensive as compared to commission-based models. This is primarily because fee-only financial advisors spend more time and effort in analyzing and customizing a financial plan attuned to your goals. Plus, the variety in their fee structures ensures that there are many more variables to consider while evaluating their bill.
- The investment process with fee-only financial advisors may be more complicated because they do not work directly with companies that market investment products. Therefore, the client may have to work with a separate broker/dealer to finish the transaction. The extra step can inflate costs and time for the process.
- Fee-only financial advisors may also have a more limited menu of investment choices on offer because product marketers do not see tangible benefits in engaging with them.
To know more about how financial advisors are getting paid, and other fee structures, read this article: How Financial Advisors Make Money
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About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.