What’s the Difference Between a Fee-Based & Commission-Based Financial Advisor?
A financial or investment advisor is a finance professional who analyzes and manages portfolios. They can also help clients plan for real estate transactions, college savings, and even complicated tax scenarios. In choosing an advisor, you have two typical fee structures: fee-based and commission based. Let’s explore the differences so you can make a well-informed decision in choosing your advisor.
Fee-based financial advisors
Fee-based advisors received a pre-determined fee for their services, which could be a flat rate retainer or an hourly rate per consultation. Sometimes, fee-based advisors require their clients to have a minimum asset amount, as the fee can be represented as a percentage of the client’s portfolio. Some advisors charge monthly; others may choose to charge quarterly or annually. Certain additional services, such as estate planning or portfolio checkups can also incur an additional charge. Fee-based advisors are paid primarily by their clients for services rendered but some of the advisor’s revenue may also come from selling various financial products, like insurance or mutual funds.
Fee-based advisors have a fiduciary duty to their clients, so they will always place your best interest first. These advisors must thoroughly analyse all investments before making any recommendations and execute trades to the best of their ability. That said, fee-based advisors tend to be more expensive than commission-based advisors, since the annual 1%-2% fee that fee-based advisors charge will eat into returns.
Commission based financial advisors
Commission-based advisors’ income depends primarily on the products they sell or the accounts they open. Like fee-based advisors, these products can be insurance packages and mutual funds. Commission-based advisors usually work for major firms like, Edward Jones or Merrill Lynch, but only nominally. They usually resemble independent contractors. Commission-based advisors receive no salary from their contracting companies, but instead receive operational support from them. In order to get this support, the advisor must give the firm a portion of their earnings. Another caveat is that commission-based advisors are often rewarded for engaging their clients in active trading. So, some advisors might buy and sell excessively to receive continuous payments.
Commission-based advisors can be fiduciaries, but it is not mandatory. They are obliged to follow the suitability rule for their clients, but they don’t have a legal duty towards them. Commission-based advisors’ fiduciary duty is to their employing dealer(s)/broker(s). One major criticism surrounding commission-based financial advisors is that they may not always act in the best interests of their client. If the advisor earns a commission from selling a product, how can the client be confident that recommended investment or product is really the best option for them?
So, what is your best option?
Both types of advisors come with their pros and cons. Generally speaking, investors with large portfolios in need of active management may see fee-based advisors as their best choice. On the other hand, investors with smaller portfolios having less need for active management may find commission-based advisors more suitable. Fee-based advisors tend to be more expensive, taking a larger chunk of your returns, while commission-based advisors are less expensive. Fee-based advisors provide more personalized and safer services, while commission-based advisors tend to prioritize increasing their commissions. No matter who you go with, always make sure your advisor is working in your best interests first.