So I’m going to come into your office, and you’re going to look at all my money and tell me what to do with it…. What’s in it for you, pal?
It’s a completely reasonable question to ask. There is an ongoing debate within the financial services industry over the most “ethical” way for financial planners to get paid. What is the consensus?
The answer, like most things in life, is: it depends.
(I know, that answer is frustrating. But let me explain….)
Fee vs. Commission
A financial planning fee is pretty much exactly what it sounds like: the client writes a check to a financial planning firm for its services. The price and frequency of the fees are determined by the financial advisor. Some bill per meeting, hourly, or annually, depending on the firm’s policies and the needs of the client.
Normally a new client comes in for an initial consultation, and then is presented with a financial plan at the follow-up meeting. The financial planner has the ideas and the strategy, but ultimately the bigger financial institutions have the products (ie. mutual funds, life insurance policies, annuities, FDIC-insured bank accounts, etc.).
If any of the plan’s action items require implementation through one of these financial institutions, the advisor will recommend the companies with the best product for their client’s needs. By delivering business to that financial institution (whether it be a bank, or a brokerage firm, or a mutual fund complex), some advisors receive compensation from the institution as a finder’s fee or a commission.
Where’s the Beef?
The whole discussion over fee vs. commission is over emphasized, in my opinion. Both expenses are coming out of the consumer’s pocket, so it’s really a matter of packaging.
Some regulators will have you believe that accepting a commission presents a conflict of interest, that compensation from financial institutions incentivizes planners to pick one product over another regardless of the client’s best interests.
On the flip side, there are instances where a commission makes a lot more sense than a recurring fee. Some clients only need to make a one-off trade, yet find themselves stuck paying recurring charges from a fee-only advisor. Those clients might prefer a one-time commission fee instead.
As long as the commissions are disclosed by the advisor and the savings from those commissions get passed onto the client, there’s no real ethical dilemma here. Advisors should be upfront about commissions with their clients from Day One.
The financial services industry spends so much time and money and angst over this argument, when the solution is simple: every client is different. Advisors should be making plans and negotiating compensation based on each client’s unique set of needs and financial circumstances.
Two Key Phrases Clients Need to Look For
After verifying that the financial advisor is a Certified Financial Planner (CFP®), the key phrase that every client needs to look for is “dually-licensed.”
Here’s why: If your financial planner wants to talk investments, he or she has to be either a registered rep or an investment advisor rep. An investment advisor rep charges fees to manage your money. They do not produce products, nor do they get any income from the placement of products. Registered reps sell products and earn a commission. Dually-licensed planners have the ability to wear both hats, depending on which formula works best for the individual client.
Working with a dually-licensed planner is best for the client for 3 reasons:
1) Dually-licensed planners determine which brands of product they want to sell
An advisor can only be a registered rep for one firm. A registered rep for a big national firm can only sell that firm’s approved products, while dually-licensed planners can shop around from place to place and figure out which products work best for each unique client.
John Bodnar, CFP®, CIMA® is dually-licensed. Learn more about Bodnar Financial here.
2) Dually-licensed planners are more resilient in a chaotic regulatory environment
The sands are constantly shifting in the regulatory world. The SEC can’t make up its mind on whether or not fees or commissions are more vulnerable to abuse. First, the SEC sounded the horns accusing advisors of doing unnecessary trades just to make commissions. Years later the same agency complained that reps weren’t trading enough, and accused them of neglecting accounts. In other words, the agency wondered, “what are advisors doing to ‘earn’ their fee, now that we pressured them to move over to fee-only?”
Dually-licensed financial advisors get paid in both fees and commissions. Whichever form of compensation the SEC decides to audit, the dually-licensed practices will be standing when the dust settles.
3) True fiduciary is flexibility, not fee-only
Financial planners have an ethical and legal fiduciary responsibility to act in the BEST interests of their clients.
While fee-only financial planning is more convenient for regulators, that doesn’t mean it’s best for clients.Click to tweet
For example, a fee-only firm might recommend a money management program with an ongoing fee, when all the client really needs is a one-off mutual fund instead. While this recommendation might meet the regulatory “suitability standard,” which basically means it’s a good enough option for the client but maybe not the best, it fails the fiduciary test.
In reality, the regulators forced firms into a square hole (fee-only), and left planners to make their clients’ round pegs fit. That’s the real conflict of interest, if you ask me.
Here’s the Bottom Line
Compensation should be negotiated to reflect the preferences of the advisor and the client.
Clients should ask themselves:
Are my advisor and I defining a goal and accomplishing what we set out to do?
Do I trust my advisor? Do I connect with them? Do I like them?
Ultimately, there is no way to micromanage the ethics of an entire industry (sorry regulators!). And the entire point of having a financial advisor is to not have to become an expert on all of this stuff.
That’s why shopping around and finding a financial advisor that you trust is so important. To the best of your research and knowledge, you assume your doctor is practicing ethical medicine. To the best of your research and knowledge, you assume your personal trainer is knowledgeable in fitness and nutrition. To the best of your research and knowledge, you assume your babysitter isn’t a crazy person.
Financial planning is a service industry- be sure to vet your financial planner as rigorously as you would for any other major investment in your lifestyle.
(Just starting the process? I have some free advice on the “5 Things That Actually Matter” when choosing a financial planner. You can check it out here!)