If you are a reader of our financial planning blog, you may have noticed that many posts close with some variation of the following:
If you’re unsure of how to structure your investments, or if you’re uncertain if short-term investments are right for you, work with a fee-only financial planner to help you navigate the important variables of your risk tolerance and investment time horizon. Without the conflict of interest stemming from the desire to earn commissions from selling products, a fee-only financial planner can determine the best solution for your investment needs.
Though the above blurb is a bit of a self-serving advertisement, the ideal it espouses lies at the root of our fee-only financial planning firm. We, at Wealth Analytics, strongly believe in the fee-only model because it allows us to provide the best possible financial advice to our clients. To us, it simply makes sense to put the client’s interests first; it’s simply good business.
What is a Fee-Only Financial Planner?
If you are unsure of what a fee-only financial planner is, just refer to the blurb above; it explains what makes a fee-only financial planner so great: fee-only financial advisors provide uncompromised financial planning advice because there is no conflict of interest stemming from the desire to earn commissions from selling products.
Naturally, our opinion that fee-only financial planning is terrific is biased. So you do not have to take our word for it. Financial journalist Jane Bryant Quinn, consumer expert Clark Howard, personal financial guru Suze Orman, and non-profit organization Consumer Reports are all in agreement about the value of electing a fee-only financial planner:
If you need professional help with your finances, we’ve long recommended using a fee-only financial planner to avoid conflicts of interest.
~ Consumer Reports, independent non-profit organization seeking to empower and protect consumers
You should be told up front how, and how much, a potential adviser will be paid. [ . . . ] The correct method of payment is by fee only.
~ Suze Orman, Personal Financial Guru
The stakes are so high in investing that Clark urges you to consider fee-only planners. [ . . . ] You won’t have to worry about conflict of interest.
~ Clark Howard, consumer expert
The best way to protect yourself [ . . . ] is to switch to a fee-only investment adviser. Fee-only advisers sell no products and take no commissions, they charge only for their advice.
~ Jane Bryan Quinn, financial journalist
Brokers, Financial Advisors Receiving Commissions for Sales, and other Salespeople
Since the fee-only model allows a financial planner to give their clients the best possible service, it begs the questions:
- If you’re not a fee-only financial planner, what are you?
- How can conflicts of interest show up when receiving financial advice?
In the financial services industry, there is a dividing line separating two completely different business models: the fee-only model (just discussed) and the alternative. You may find that the financial advice that you receive may differ depending upon how the financial planner providing the advice is compensated. If, for example, the financial planner is compensated on the basis of selling certain products, you may find that the investment advice may be compromised in favor of you buying the particular products that the financial planner has for sale. That is, when dealing with a financial advisor who is compensated via commission, you may find yourself receiving a sales pitch cloaked as investment advice.
To be clear, not all brokers and financial services salespeople are out to gouge their clients. Many brokers truly have the best interests of their clients in mind. However, the compensation model (i.e. commissions from sales) creates the conflict of interest. Further, for many people, the broker is the only option. This is because working with a fee-only financial advisor may simply be cost-prohibitive.
There’s No Money in Lettuce
Why do brokers and other commissioned sales people (i.e. “financial planners” who are not fee-only) do this – recommend only those financial products that they have for sale? To answer that question, let’s use an analogy that we can all relate to: weight-loss.
Concerned about his growing waistline, Oliver Hardy seeks weight loss counseling services from William Taft Foods (WTF), Incorporated. The representative at WTF, Inc. offers to sell Hardy several pre-packaged frozen meals. The packaged food is high in sodium, and loaded with artificial preservatives, and other chemicals. The WTF, Inc. rep assures Hardy that eating a strict diet of these meals will get him in shape in no time.
The story above shows how the WTF, Inc. rep recommends that Hardy purchase the processed food. A dietitian – or probably any individual without processed foods for sale – would recommend that Hardy implement a regular exercise regimen, and switch to a diet of whole grains, and raw fruits and vegetables.
Why is the WTF, Inc. rep’s advice so different from what a dietitian would recommend? It’s actually pretty simple: it stems from a conflict of interest. WTF, Incorporated’s business comes from selling packaged foods – not providing dieting advice. That is, the WTF rep can’t make any money by saying, “eat healthy and exercise.”
However, the rep does earn a commission each time he sells WTF’s prepackaged meals. Reps at WTF, Inc. function as sales people. The same is the case with your broker, insurance agent, or other financial planner who is not fee-only.
Conflicts of Interest
The above analogy showcases how conflicts of interest affect an advisor’s recommendations. It’s the same in the financial services sector. Consider an example of a broker, or other financial advisor, who is compensated solely by the commission from the sales of products:
Hardy’s good friend, Stan Laurel, is nearing retirement. Laurel is looking for a way to invest his money. Considering his goals, liquidity needs, and investment time horizon, Laurel’s broker sells Laurel several high-cost balanced mutual funds with large sales charges.
The particular funds that Laurel purchases have not only high ongoing management expenses, but also large sales expenses (sales load). Over time, the average of the high-cost mutual funds perform relatively poorly when compared to lower-cost investments with similar stock/bond allocations.
There are countless mutual funds to choose from – many of which offer low costs. Why does the broker suggest the high fee product – and not the low-fee product? The reason is that brokers are compensated by commissions, not for fees for giving advice. (Brokers are not fee-only financial planners.) Without commissions from selling products, there is no money for the broker or similar salesperson.
The broker must sell one of his expensive mutual funds to generate any money for himself. The broker does not make money when the client purchases investments outside of the broker’s inventory. And unfortunately, many times the broker suggests high-cost funds to enhance his own remuneration.
You’ve probably figured out by now that given the nature of this compensation model (a model that is not fee-only), the broker is faced with a choice:
- Suggest the financial products that fatten the wallet of the broker, or
- Suggest the financial products that fatten the wallet of the client
If the only way a broker makes money is by charging commissions, which financial planning products do you think the broker is apt to suggest to their client? The financial planner that is not fee-only (i.e. the broker) is incentivized to sell the financial product that generates the highest commission for themselves – not the product that is best for the client.
Fee-Only Financial Planning
The above is in stark contrast to the fee-only financial planning model. In short, a fee-only financial planner keeps his eye on the prize: you, the client. When working with a fee-only financial planner, you receive financial advice that serves your best interest.
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If you’re working with a broker, insurance agent, or other financial services salesperson, consider getting a second opinion from a fee-only financial planner. A fee-only financial planner is able to present an unbiased perspective on your unique financial circumstances.
Consumer Reports Online. (2011, March). What to expect from a financial planner, how to find one. Retrieved from Consumer Reports Online: http://www.consumerreports.org/cro/money/personal-investing/financial-planners/overview/index.htm
Howard, C. (2013, January 1). Fee-only financial planners are in your best interest | www.clarkhoward.com. Retrieved from Clark Howard: Save More, Spend Less and Avoid Rip-offs | www.clarkhoward.com: http://www.clarkhoward.com/news/clark-howard/personal-finance-credit/fee-only-financial-planners-are-in-your-best-inter/nDKZ/
Orman, S. (2014). Retirement Planning. Retrieved from Suze Orman : Personal Financial Guru : Can I Afford it : Suze Orman Show: http://apps.suzeorman.com/igsbase/igstemplate.cfm?SRC=MD012&SRCN=aoedetails&GnavID=84&SnavID=25&AreasofExpertiseID=71
Quinn, J. B. (2010, January 24). Why you get bad investment advice « Jane Bryant Quinn. Retrieved from Jane Bryant Quinn: http://janebryantquinn.com/2010/01/why-you-get-bad-investment-advice/