Fee-Based vs. Fee-Only Financial Planning: What’s the Difference?

Do you often find yourself questioning the “word-salad” in financial services? 

I’ve spent a lot of time in the academic field of finance. I quickly realized that I had to break down the industry jargon for the average investor (at that time I was one!) so that I would be better informed in my decisions. There are many confusing terms. I wonder if it's intentional?

Believe me! Money is being made off of the use of confusing terms, the investor’s lack of practical hands-on experience, the complexity of portfolios (completely unnecessary), and the fear of seeming uneducated. Nobody wants to feel dumb!

So here’s my attempt to break down one of the more confusing issues, "Fee-Only" and "Fee-Based". Perhaps the next time you have a conversation with an advisor, you’ll have a little more knowledge and confidence. 

First, no fee schedule is inherently bad- as long as the consumer/investor is fully aware of the compensation model. However, I see distinct disadvantages in some models.

Why “Fee-Only” Isn’t as Simple as It Sounds

What does Fee-Only mean? It means that the advisor doesn’t receive any other form of compensation beyond what the client pays. But.... That compensation can be broken down into several categories: 

• AUM Fee- (Assets Under Management). The fee is based on a percentage of total assets. typically using a graduated scale that can become complicated but often, the all-in average is around 1.4%. *Currently the industry norm, I'd like to change that.

  
  

Managing $1,000,000 at 1%= $10,000. This fee can be assessed daily, weekly, monthly, quarterly, etc and it’s often pulled directly from the account. You don’t usually see a “bill”...it’s listed in the statement- but you likely won’t find it on page 1! You’ll have to look through the transaction summary pages and then do some math to project the annual fee based on future investments and projected growth of assets. Complicated!

• Annual Retainer- (often called Flat Fee, Set-Fee, or Ongoing-Fee). This is a fixed fee paid to secure ongoing services. 

  
  

• Hourly Planning- based on a published hourly rate and applied based on the time taken to perform the mutually agreed upon work. *Think attorney and billable hours.

  
  

• Project-Based Fee- used as a substitute for Flat-Fee and Hourly Rate. It’s a set, agreed-upon price between the client and advisor for a specific service. This is most-often used in a one-time limited engagement or for a special project.

How “Fee-Only” Differs from “Fee-Based”

What does Fee-Based mean? It means the advisor can receive Fee-Only as well as Commissions. So how do advisors get commissions? Commissions are typically paid to advisors when you purchase the following:

• Insurance Policies- advisors can receive 50% - 100% of the 1st year’s premium. 

• Annuities- advisors can make 1% - 8% of the initial premium or an ongoing 1% - 3% annually for fee-based annuities. Gets confusing right? 

• Mutual Funds- (with Front-end Fees it can be 2.25% - 5.75%) otherwise 0.25% - 1.5% annually.

• Other Investment Products- (Individual stocks, bonds, options) usually range from 05% - 1.5% annually

  
  

**A real concern with fee-based is whether the advisor’s recommendations meet the client’s needs and the fiduciary standard. If we're honest, we've all had situations where an action or decision was "justified" as appropriate when really, it was only most-appropriate for us!

Advisor Compensation Can Introduce a Strong Bias.

It might be difficult for an advisor to avoid the mutual fund paying him a 5.75% front-load fee- after all, the client needs exposure to that asset class anyway. Likewise, if an advisor earns a commission every time an insurance policy is sold, it becomes difficult to ignore the possibility that more clients may ‘need’ insurance, or an annuity, or front-end loaded mutual fund... or perhaps all of them!

Compensation Influences Perspective.

Check your investments- do you have any front-load mutual funds? If so, ask why and exactly where the $5.75 of every $100 you've invested went. Then see if the returns you've received significantly outperformed the index fund or a comparable no-load fund. Do the same with other products. Know what you have, exactly why you have it, and how others were/are compensated. It's you're money and your future- you have a right to know.