When shopping around for a financial advisor for your retirement planning, you’ll likely encounter the term “fee-only.” You’ll also probably see other professionals describe themselves as “fee-based.” Others, yet, may not even mention fees and instead are likely paid on commission.
And you may wonder what the difference is.
That is an excellent question, and in fact, a critical one.
17 Billion Reasons You Need to Know
As a consumer, it is natural to think that most financial advisors are alike. They all give financial advice, right? Unfortunately, the reality is not so simple.
Wall Street is and always has been far from transparent with consumers. According to FINRA, the U.S. regulating authority, conflicts of interest are “widespread across the financial services industry.”[i]
Just how widespread are these practices? A 2015 report by the White House Council of Economic Advisors estimated that this conflicted advice costs American retirement savers an estimated $17 billion…every year.[ii]
These conflicts of interest are especially predominant with the big brand name firms. While their advertising makes them sound attentive to your needs, their business models prioritize generating profits for the firm’s shareholders. Even the most ethical advisors who work there may be pressured to focus on sales, not your long-term results. While some firms offered luxury vacations and other high-value awards for increasing sales, some financial advisors even reported being docked pay for failing to meet quotas.[iii]
The Downside of Commissioned Financial Advice
This pressure to sell certain investment products creates something called “conflicted advice.” This is where you believe you are getting true advice, but instead you may be getting recommendations that benefit the firm more than they benefit you.
That in itself is dangerous, as paying more than you need to for investment products can erode your wealth dramatically over time.
But the impacts of conflicted advice go even farther. When you are planning your financial future, you can’t afford to overlook any important aspect of your financial life. But when you get conflicted advice, your plan and your blind spots are not always the central focus. So important areas and proper risk management may be ignored, putting your future at risk.
Your best bet? Take sales out of the equation by avoiding commissions altogether.
Fee-Only Financial Advice Minimizes Conflicts
Fee-only advisors don’t accept any commissions or third party payments, so you can eliminate much of that conflict of interest. Instead you pay them as you would your accountant or lawyer, with a fee.
So as long as you hire someone compensated by fees, you will get advice, not product recommendations.
Fee-Only or Fee-Based?
The devil, however, is in the details. Most fee-only financial advisors are independent, smaller firms. It’s just not as profitable a business model for the big Wall Street firms. But those Wall Street giants did not want to lose out on market share, so they created a new type of advisor category. That’s a fee-based advisor.
While it sounds similar, fee-based is not the same as fee-only. While they may not charge commissions for traditional investments, these fee-based firms do charge commissions part of the time, usually when they sell you insurance products, such as insurance policies and annuities.
And insurance products happen to be some of the highest commission products out there.
Insist on a Fiduciary
A key aspect of this entire industry is that there are two separate service standards in the financial advisor world. One is the fiduciary standard. A fiduciary is required to put your interests first. If they don’t, there are legal consequences.
As you can probably see, when your financial future is at stake, it is highly recommended that you only deal with a fiduciary.
True fee-only financial advisors act as your fiduciary all of the time.
Fee-based financial advisors usually act as your fiduciary when managing your traditional investment portfolio, but then don’t have that same standard when offering you insurance or annuities. They are required to disclose that to you, but here’s the problem. It might be in fine print in something you signed in the past. So in essence, you have to be on guard to figure out what is real advice and what is a sales pitch.
Will You Act as My Fiduciary At All Times?
Fortunately, there is an easy way for you to cut through the confusion and protect yourself. You should ask a potential (or current) financial advisor if they will act as your fiduciary 100% of the time. High quality, fee-only advisors appreciate educated clients and will gladly confirm that in writing for you.
On the other hand, a firm that will not act as your fiduciary at all times may hesitate when asked. If they seem surprised at your question that may be a valuable red flag that can save you significant money and stress down the road.
With Reg BI in place now, the suitability standard is no longer current. While BDs and RRs are not held to a fiduciary duty, they do in fact have to work in the best interests of the clients. Registered Investment Advisors and Investment Advisor Representatives act as fiduciaries for all of our investment management clients. We have an obligation to act in the best interests of our clients and to make full disclosure of any conflicts of interests, if any exist. Please refer to our firm brochure, the ADV 2A page 4, for additional information. So, don’t be shy…ask! And get it in writing. Your future is too important.
Planning Your Retirement
Now, that simple step can help you narrow down your choices to fee-only financial advisors who agree to act in your best interests at all times. But since your choice of financial advisor can make or break your retirement, don’t stop there.
Retirement planning is a specialty. Not all financial advisors are focused on this, so may not have the experience to help you avoid pitfalls and problems. You don’t want someone’s learning curve dictating the quality of life you can afford after you stop working.
So find out how much retirement planning the advisor actually does. Is it 20% of their practice, or all of it? Ideal world, if you’re preparing for retirement, you should get a specialist. More experience and expertise can mean more security and less surprises for you.
Don’t Forget Taxes
One critical area that a surprising number of financial advisors ignore or downplay is taxes. But taxes impact every aspect of your financial life. If you don’t pay attention to reducing your taxes, you’ll have less to save…and have to earn more to overcome that cost.
On the other hand, finding strategies to reduce your taxes makes it far easier to reach your financial goals.
And it’s not just before retirement, either. Once you’re retired it becomes critical to optimize withdrawals to minimize your taxes…but many financial advisors pay little attention to this critical aspect.
So ask your prospective advisor what tax planning help they provide. For best results, it should be a fixed part of their process and included in their standard fee.
Holistic Planning For Your Best Results
A retirement planner who specializes in comprehensive advice can also help you identify opportunities to improve your future financial situation. For example, many people just sign up for Social Security without a second thought. But doing that may leave valuable future income on the table.
The right financial advisor can help you research your options and select the strategy that will help you achieve the best result.
The same applies with blind spots. Planning is never perfect, and we’ve all met people who got knocked off course by an unexpected injury, illness, or family death. You don’t want to have to downgrade your lifestyle, especially late in life. A quality retirement planner should help you examine your situation and actively look for places you might be vulnerable. They can then help you with insurance coverage and risk management to help make sure you’re prepared for these types of events. At the same time, they can also help you make sure you’re not overpaying for extra coverage you don’t need.
Get a Second Opinion
As you can probably see, hiring a financial advisor is not a decision you should take lightly. Hiring the wrong person could be costly, so take your time and do your research.
Keep in mind that most financial advisors will offer you a free consultation. This allows you to get a second opinion on your current financial situation. At the same time, you see if this person is a good fit for your needs. Even if that person is not a fit, you’ll get valuable insight from a new set of eyes for no cost but a bit of your time.
Just as you would with a significant health decision, take advantage of these second opinions. Doing so might just mean the difference between a happy retirement versus one full of financial stress.
Social Security Disclosure:
Kyle Hammerschmidt and/or MOKAN Wealth Management are not affiliated with or endorsed by the Social Security Administration or any other government agency.
[i] https://www.finra.org/sites/default/files/Industry/p359971.pdf
[ii] https://obamawhitehouse.archives.gov/sites/default/files/docs/cea_coi_report_final.pdf
[iii] https://www.startribune.com/how-brokers-big-bonuses-can-lead-to-ruin/507415292/