Understanding the Two Major Advisor Classifications

September 14, 2018  |  Michael Reilly

The classifications for financial advisors and the standards we hold them to has changed several times over the years.

Currently, there are two broad categories of financial advisors you should be aware of, Fee-based and Fee-only.

One of these advisors is legally required to put their clients’ best interest first. The other is only required to recommend investments that are “suitable” for their clients, and they’re allowed to earn commissions on the side.

Now these two categories, fee-based and fee-only, sound very similar…and there’s a reason for that.

Up until fairly recently, Fee-based advisors were often referred to as Commission-based advisors. However, once more and more people started to realize that fee-only advisors existed, and that they were generally a better option, the popularity of commission-based advisors started to wane.

At this point, this new classification, the Fee-based advisor, emerged. The term was created to be as similar as possible to the fee-only classification. Commission-based advisors wanted to move as far away from any mention of “commissions” as possible and adopt a new name for themselves that closely resembled the “Fee-only” classification.

Thus, the term “Fee-based” was born.

It’s not unreasonable to assume that the term “Fee-based” was created to deliberately confuse individual investors who haven’t had the time to research the playing field.

Imagine this…an investor – let’s call him “Dave” – unexpectedly comes into a large sum of money. Maybe a family member passes away and leaves Dave a seven-figure sum, or he hits the mega-jackpot at his local casino, something like that.

Now, let’s assume that Dave’s never really had access to this amount of money before and he’s never done any research into financial investment. Maybe he asks a friend who says something like: “Get an advisor, and make sure they’re fee-only.”

So, Dave googles “local financial advisors” and calls the first number that pops up. He gets in touch with an advisor and, when he asks if they’re fee-only, the advisor responds, “We’re fee-based”.

Now, most people would probably do a little more poking around to figure out what “fee-based” really means, but the two terms are so similar that you couldn’t really blame someone for thinking they’re the same, especially if it’s someone like Dave with no prior experience in financial investments.

This is exactly what fee-based advisors bank on, and you can bet that there are millions of dollars that have been mistakenly placed in their care as a result.

So, what’s the big deal?

Are fee-based advisors really all that bad?

Well, not necessarily. We’re sure there are some commission-based advisors out there that genuinely act in their client’s best interest. Some investors may even intentionally choose a fee-based advisor because they tend to charge lower initial fees.

The thing is, fee-only advisors are, at the end of the day, held to a much higher standard. All fee-only advisors are technically fiduciaries, which means they’re legally required to put the best interests of their clients first. The “only” in fee-only refers to the fact that these advisors are not allowed to collect commissions on products and services they recommend to clients.

Plus, because fee-only advisors are often earning fees based on a percentage of assets managed, there’s a financial incentive for them to grow your accounts as much as possible.

Meanwhile, fee-based advisors recommendations are only required to be “suitable” for clients. This “suitable” term is fairly loose and, at the end of the day, fee-based advisors are more likely to uphold the interests of their employing brokers or dealers, rather than their clients.

On top of that, fee-based advisors are allowed to collect commissions (remember, they used to be called commission-based advisors), and unlike fee-only advisors, they’re not legally required to disclose conflicts of interest.

So, at the end of the day, fee-only advisors are going to offer you peace of mind in a way that fee-based advisors don’t…that’s important. Especially if you’re trusting them with your most important assets.

Remember, fee-only advisors are legally required to put your best interests first, and they have a financial incentive to do so. In fact, if a fee-only advisor were to take a commission or recommend anything other than “the best” to their clients, they would very quickly lose their certification.

If you’re not sure which category your current advisor falls into, we highly recommend you request full details (in writing) of their compensation. As a client, you’re entitled to this info, and it should plainly state whether they’re fee-only or fee-based.

If you’re in the market for a new financial advisor, consider scheduling an appointment with our team.

We can help you further understand how fee-only advisors can manage and grow your accounts, and we even have fee-only advisors on staff if you want to speak to one right away.

An appointment with our advisors carries no obligation, you’re more than welcome to simply call in and ask us a few questions.

Click here to see available appointment times.

As always, invest wisely.

Get Our FREE Guide

How to Find the Best Advisor for You

Learn how to choose an advisor that has your best interests in mind. You'll also be subscribed to ADAPT, Avalon’s free newsletter with updates on our strongest performing investment models and market insights from a responsible money management perspective.

Avalon_NewGradient_24Feb22 copy