What is a Fee-Only Advisor?
Key Points:
• Fee-only advisors are financial advisors who are compensated based on flat fees, hourly rates, and or assets-under-management (AUM) parentages. They are legally and ethically unable from accepting commission-based fees.
• This compensation method obviates conflicts of interest that fee-based or commission-based advisors might incur. It guarantees that fee-only advisors are providing objective advice, making them advisors highly desirable.
• There are various types of fee-only advisors, ranging from algorithm-based robo-advisors which focus on investment management to registered investment advisors who work with high-net-worth individuals.
• Despite the myriad upsides of fee-only advisors, prospective advisees should still do due diligence to determine whether specific advisors are competent and compatible with them.
• A number of online databases exist for finding fee-only advisors.
When used with regard to financial advisors, the “Fee-Only” designation has implications both on an advisor’s pay structure and on their ethical obligations. Fee-only advisors charge according to either a flat fee, a regular hourly rate, or an AUM percentage. AUM-based fees mean that an advisor receives some percentage — often 1% — of the assets under their advisement on an annual basis. Fee-only advisors typically function as fiduciaries, meaning they have legal and ethical obligations to operate in their clients’ best interests 100% of the time.
Most crucially, fee-only advisors are distinct from fee-based and commission-based advisors, whose pay structures and ethical guidelines differ. Despite the seeming similarity of the title, fee-based advisors are allowed to be compensated both by one of the flat fee models described above, but also by commissions from selling products or completing financial transactions. Because they stand to gain by selling products and/or authorizing financial transactions, this creates conflict of interest between the advisor and their clients.
Though possibly detrimental to clients’ financial lives, this conflict is not inherently illegal. While fee-only advisors are held to the rigorous fiduciary standard, fee-based advisors are held to the comparatively loose suitability standard. The suitability standard merely stipulates that all transactions be “suitable” for the client in question, not necessarily “ideal,” and not to the exclusion of the advisor’s own financial interest. Commission-based advisors, whose pay depends entirely on commissions, also incur this conflict of interest.
Due to the conflict-free nature of their work, fee-only advisors are highly desirable, and often assumed to be the best choice when hiring a financial advisor. While not always true — an advisor’s pay structure says nothing about their competence or their relevance to particular clients — the desirability of fee-only advisors has led to the advent of organizations and databases designed to collate and direct potential clients toward fee-only advisors. The National Association of Personal Financial Advisors (NAPFA) is the most prominent association of fee-only financial advisors. The Garrett Planning Network, the XY Planning Network, and the Alliance of Comprehensive Planners all operate with comparable objectives.
Registered investment advisors (RIAs), who work with high-net-worth individuals (HNWIs), and CERTIFIED FINANCIAL PLANNER™ professionals (CFP®) are prominent examples of designations that fee-only financial advisors often receive. CFP® professionals are awarded the prestigious designation only after years of education, experience, ethical rectitude, and examination. CFP® professionals must renew their designations on an annual basis, which ensures that they remain abreast of the latest legal and ethical regulatory updates.
Of course, no designation can guarantee that a particular type of financial advisor is right for you. When evaluating prospective financial advisors, you should certainly ask about their fee structure to ensure that their work is conflict-free, but you should also ask about their experience, communication preferences, specialty areas, and more. As there is no one-size-fits-all method for financial advising, there is no universally relevant financial advisor. Always seek out advisors who have relevant experience and with whom you have good chemistry.
Upsides of Hiring a Fee-Only Financial Advisor
Conflict-Free. The primary benefit of working with a fee-only financial advisor is their legal and ethical obligation to act in their clients’ best interests 100% of the time. This obviates all potential conflicts of interest and ensures that all advice is entirely objective. With other types of advisors, clients will constantly wonder whether the advice they’re receiving is ideal, or whether it has some hidden upside for the advisor. With fee-only advisors, that consideration practically never enters the equation.
Knowledgeability. Fee-only financial advisors often undergo extremely thorough and rigorous training in order to attain their designations and/or certifications. Because of this, they emerge with an enormous amount of knowledge and insight. Advisors held to the less rigorous suitability standard do not have to complete this level of background training and therefore may be able to provide advice on a relatively limited basis.
Flexibility. Fee-only advisors can serve their clients on a variety of scales. They can give objective second opinions on a specific financial question, or they can generate a comprehensive, holistic financial plan. They can answer periodic questions, or they can review and reallocate an investment portfolio. They can do all of these things if their clients wish.
The vast insight, flexible services, and conflict-free nature of fee-only advisors make them more desirable than their differently paid counterparts.
Possible Downsides of Hiring a Fee-Only Financial Advisor
While the upsides of hiring fee-only financial advisors are fairly easy to identify, the possible downsides can be a bit less obvious. Often, too, they can be avoided with the right amount of due diligence and proactivity on the part of the advisee. In order to do so, it’s important to recognize their possible sources.
Cost. Many suggest that fee-only advisors are more expensive than fee-based or commission-based advisors. Some of this is due to the level of their fees, and some of this is due to possible conflicts. That is, if a commission-based product is the ideal choice for a client, that advisor will not be legally permitted to sell it, because they would benefit financially from the transaction. This is not a regular occurrence but is a possible source of additional cost.
Assumptions. Because of the desirability of fee-only advisors, some clients assume that they are inherently more competent and qualified than their fee-based and/or commission-based counterparts. While it’s often the case that clients (especially HNWIs) prefer fee-only advisors, the designation alone does not ensure that they’re the most competent option. When hiring a financial advisor, never assume; always do thorough due diligence before signing on the dotted line.
What Kind of Fee-Only Advisor Should I Hire?
To assess the relevance of fee-only advisors, prospective advisees must assess their financial circumstances and their financial objectives. There are a range of advisor types to choose from, and different conditions will necessitate different levels of advisors.
Level One: Robo-Advisors
For individuals with relatively small investment portfolios, robo-advisors are often a reasonable low-cost option. Often working on an AUM-based fee schedule (.25% is common), robo-advisors ask a number of questions upfront, and rely on algorithms to design investment portfolios fitted to clients’ specific objectives. Being robots, they are not equipped to answer specific questions, and they are unable to provide holistic financial planning advice.
Level Two: Robo-Human Hybrid
For slightly higher fees, individuals can receive a combination of algorithm-based investment portfolios and periodic access to human input. Firms that operate in this way charge flat fees often starting at .89% and rising based on the complexity of their portfolios.
Level Three: Traditional Financial Planning
This is traditional, in-person, human-to-human financial planning. It is the most thorough and comprehensive kind and provides clients with the most accessibility to their advisors. HNWIs with complicated financial circumstances who want input on more than just their investment portfolios benefit most from this model.
How Can I Find a Fee-Only Advisor?
There are a number of databases that can help direct prospective clients to fee-only financial advisors in their area. Here are a few:
NAPFA. Founded in 1983, NAPFA arose out of a Society of Independent Financial Advisors meeting. The advisors in attendance agreed that the conflicts of interest arising from commission-based sales jeopardized the quality of their advice. A year after the meeting, 125 such advisors expressed interest in forming a fee-only financial planning firm. Nearly 40 years later, this group has evolved into the more than 3,000-member NAPFA, a comprehensive database for fee-only financial advisors.
The Garrett Planning Network. Founded in 2000, the Garrett Planning Network (GPN) stipulates that all of their members be fee-only fiduciaries, CFP® professionals, and available to provide advice — that is, with no requirement of long-term commitments or asset minimums. The GPN fosters community within their advisor network and provides member advisors with eLearning tools to help them expand their advising toolboxes.
XY Planning Network. The XY Planning Network (XYPN) focuses on Generation X and Generation Y clients. Like the GPN, the XYPN aims to foster community among their member advisors, arranging for seasoned advisors to share insights with and mentor their younger advisors. All advisors must be fiduciaries, CFP® professionals, and fee-only advisors, with a minimum of three years of experience.
Alliance of Comprehensive Planners. The Alliance of Comprehensive Planners (ACP) requires similar backgrounds among their advisors to the previous three organizations — namely: that they be fiduciaries, and that they be able to provide comprehensive financial guidance. The ACP is unique in their emphasis of tax-focused advice. Like the other networks, member advisors hold a number of certifications, including CFP®, CPA, PFS, CFA, JD, CDFA, EA, and MBA.