We often get a lot of questions about how much we charge, our fee structure, and the difference between our company and others. Some clients actually say, “We don’t have to pay our current advisor.” This is a dangerous situation because no one works for free! In these scenarios, the client doesn’t understand how the advisor is being paid and the advisor is likely not being straightforward.
There are three basic types of financial advisors – commission only, fee-only, and fee-based advisors. AAFMAA Wealth Management & Trust works as a fee-only advisor serving military veterans. Below discusses why we think fee-only is the best approach for our clients.
Commission Only Advisor
This is the traditional operation you see in movies like The Wolf of Wall Street or when you think about your traditional stock broker. We can also look at various brokerages like TD Ameritrade, E-Trade, Share Builder, or USAA that charge a small fee for each transaction - it might be $5 to $7 per transaction. That fee gets collected on each transaction regardless of the gain or loss. As you move into financial planning and wealth management services, these commissions get bigger. The above brokerages do not offer advice or guidance with your investments. They offer a platform for you to execute transactions. The advisor is going to provide expertise and assistance with the investment management and products offered. It may seem like the advisor is not being compensated but they are creating income from a fee charged on each transaction. This applies to the investment management and other products like annuities and life-insurance.
A commission advisor is incentivized to increase the number of transactions with his client in order to create more revenue. One example, all things be equal, a client’s portfolio will generate an 8% return without making any changes. The advisor may recommend the client shift his portfolio into new positions to generate the same 8% return. The client may not need to buy, sell, or make any transactions but the advisor may recommend a shift in order to generate more fees. The advisor may also recommend a certain mutual fund over another mutual fund because it offers a higher commission. Why does this happen? Because they are incentivized by certain services and products that generate more revenue.
With annuities the advisor is most likely collecting a 5%-10% commission on the annuity. So if a client buys a $300,000 dollar annuity then the advisor is collecting between $15,000 and $30,000. The advisor can also get residual income around 1% as long as the client maintains the annuity. The commission structure for life insurance products can be even higher than the above structure for annuities.
A fee only advisor, like AAFMAA Wealth Management & Trust, charges a flat rate through a fee or percentage. Fee only advisors do not earn commissions or fees based on their products. For instance, a fee-only advisor may charge a 1% fee on the total assets under management and that fee covers everything. There are no transaction fees for buying or selling securities. The 1% fee covers the knowledge, experience, management, and operational support necessary to maintain your portfolio.
Unlike the commission driven and fee-based advisor, a fee-only advisor sits on the same side of the table as the client. What does this mean? Another common statement we hear is that “a fee-only advisor gets their fee regardless of how the assets perform?” A commission based advisor still receives his commission, good or bad, as we discussed above. If you assets go down, the fee-only advisor’s percentage also goes down. If your assets go up, the percentage goes up. The fee-only advisor doesn’t care about fees from transactions, products, or commissions. The fee-only advisor cares about the success of the clients. If the clients are successful then the advisor will be successful.
This is the advisor that mixes both worlds. A fee-based advisor will typically charge both a fee on the assets under management, like the fee only advisor above, but also collects a commission with some products and services like annuities and life-insurance. One situation, the advisor could recommend a low risk bond fund and collect a small fee or collect a bigger commission with a suitable annuity. So a fee-based advisor offers the knowledge and experience under the fee only system but can offer other products that pay a commission. The incentive still exists for the advisor to recommend products or services that offer the greatest reward or commission.
Who is right for you?
Regardless of the fundamental differences discussed above, the right advisor for you can be any one of these. It is important as an investor and client to understand the types of advisors and the relationship that will develop with the advisor. Each person has certain needs and requirements for their insurance, investment, and retirement strategies and it is important to find the right partnership to achieve your goals.
If you are ever confused, unclear, or uncertain about services or transactions with your account, you can ask for help. A lot of advisors offer a free second opinion. They will review your portfolio and provide feedback about the performance and risks.