How a Fee Only Fiduciary Puts More Money in an Investor’s Pockets
When you’re looking to hire a financial advisor to help you manage your money, you want someone who puts your interests above all else. After all, you’re paying them to help you grow your nest egg, not theirs. This point may sound obvious, but in reality, it isn’t. Lots of financial advisors are only looking to line their own pockets, but fee only fiduciary financial advisors put more money in an investor’s pockets.
The Importance of Fiduciary
Just about anyone can call themselves a financial advisor because there are no general license requirements to become one, although there are specific license requirements to trade stocks, for example. Basic financial advisors do not have fiduciary duty, and only need to make recommendations that are suitable for the investor, not necessarily ones that are in the investor’s best interest or cost the least amount of money.
A fiduciary financial advisor is a Registered Investment Advisor (RIA) who is legally obligated to act in the best financial interest of the investor. A fiduciary focuses on giving quality advice rather than on selling a particular product to collect a commission.
Fiduciaries are a subset of financial advisors who face more stringent legal and ethical standards. Thus, all fiduciaries are financial advisors, but not all financial advisors can be fiduciaries.
Beware of Sales Commissions
To further clarify the difference between a financial advisor and a fiduciary financial advisor, let’s take a look at an example that most people can relate to.
Let’s assume you’re looking to buy a new car, but you’re not sure which car is right for your needs. You would like someone to help you make a decision.
So, you walk into a car dealership and encounter a nice “car advisor” who gives you a tour around the showroom and recommends the shiny car parked next to the showroom window. The car looks great and you love it, but you’re not sure if the price is right. The advisor convinces you to buy it anyway and makes a handsome commission when you sign on the dotted line. Because they are not rewarded financially to sell the best deal, the advisor will never recommend something cheaper, as that would only earn him or her less money.
The “fiduciary car advisor” on the other hand is an independent third-party who doesn’t work for a particular dealership and doesn’t get paid a sales commission. The fiduciary works for you, and will recommend a car that is not only suitable for you, but also one that is in your best interest.
Conflicted Investment Advice
The difference between a financial advisor who works on commission and a fee only fiduciary financial advisor is also obvious when it comes to recommending stock investments. This can happen in three ways.
First of all, faced with two identical stocks or mutual funds that pay different commissions, a general financial advisor is much more likely to recommend the one that pays higher commission. What’s worse is that it can often be done without your knowledge, because the commission is usually just a small percentage of the stock price. If you were not paying close attention, you may not even notice that you were wasting money paying fees that go straight into the financial advisor’s pockets.
On top of that, if you give the financial advisor free reign to your investment portfolio, they could buy and sell the stocks in your portfolio more often than necessary, simply because there are sales commissions to be made on every single trade. If asked, they could use one of any number of reasons to justify doing what’s called churning your portfolio, including timing the market, claiming to have found a better investment, actively rebalancing your portfolio, etc.
Lastly, just like the salesperson at the car dealership, the financial advisor could be working for a firm that sells its own investment products. In this case, the firm’s management would instruct the financial advisor to recommend only the products that the firm sells, which can result in an investor paying higher commissions. It also limits the range of investments that the investor has access to.
A recent report that details the effects of conflicted investment advice estimated that it costs Americans $17 billion a year in the form of overpaying financial advisors.
The Fee-Only Model
Fee only fiduciary financial advisors focus on giving investors the best possible advice as an advocate, not a salesperson. Rather than being paid on commission, fiduciaries are compensated in ways that prevent conflicts of interest and save investors money. A fiduciary can be paid in any one or a combination of ways listed below.
- Flat Fee: A fiduciary can charge investors a flat fee for an agreed-upon type of service, such as putting together an initial retirement plan for an investor. A flat fee might be best suitable for investors who want to manage their own account after the initial consultation.
- Hourly Rate: A fiduciary can charge an hourly rate for giving investment advice, which allows an investor to only pay for time spent with an advisor, and nothing more. The hourly rate structure might be suitable for investors who are looking for ongoing investment advice sporadically.
- Retainer: A fiduciary can charge a retainer per period (i.e. monthly, quarterly or annually) and provide unlimited advice for a set fee. An investor can call or meet with the fiduciary at any time without incurring additional charges. The retainer might be suitable for investors who would like to monitor their investments closely and have frequent conversations with the advisor.
- Percentage of Assets: A fiduciary can charge a fee based on a percentage of Assets Under Management (AUM). This fee structure actually incentivizes the advisor to help grow the investor’s portfolio, because as the portfolio grows, it increases the amount of fees that the advisor can charge. This structure might be suitable for investors who want the advisor to completely take over managing their investments.
While a fee only fiduciary firm may initially sound more expensive – because they’re not claiming to be “free” and then receiving hefty commissions from third parties without your understanding – the benefits of having a true financial advocate working for you puts more money in an investor’s pockets in the long run. Again, a fee-only fiduciary will make decisions in an investor’s best interest as opposed to decisions that might not be the best and cost you hidden fees over time.
As you can see, although their titles sound similar, the difference between a commission-focused financial advisor and a fee-only fiduciary financial advisor can be night and day. When you seek financial advice, choose to work with a fee-only fiduciary financial advisor who has your best interest in mind, and who will give you objective advice that puts more money in your pockets.