When it comes to hiring a financial advisor to help you with retirement planning, you have a myriad of options to choose from. But along with that vast selection comes the difficulty of picking the right advisor for your retirement planning needs. It wouldn’t be an issue if all financial advisors were created equal. But, unfortunately, this is not the case. You will need to conduct quite a bit of proper research before you make this major decision on who to trust with managing your nest egg. After all, your financial future is at stake.
The good news is, we can help cut down the amount of time you spend on your research by recommending a solid starting point: There is already a subsection of financial advisors that make selection inherently easier; they are committed and required to work in your best interest instead of their own. They are called fee-only financial advisors.
Now, let’s go over what you need to know about these advisors, identify their main characteristics and then compare them to the other financial advisors who do not share the same commitment to serving you, the client, as their first priority.
What Fee-Only Financial Advice Looks Like
According to the National Association of Personal Financial Advisors (NAPFA), the largest organization of fee-only financial advisors, the definition of a fee-only financial advisor is someone “who is compensated solely by the client with neither the advisor nor any related party receiving compensation that is contingent on the purchase or sale of a financial product.”
What this means is that a fee-only financial advisor does not stand to earn commissions or kickbacks for recommending a particular investment to you. They charge a transparent fee (hourly, flat rate, etc.) that isn’t tied to the investment advice they give you. They look at investment recommendations as an independent party, with the sole purpose of helping you choose the best investments for your portfolio without being influenced by any outside incentives or hidden fees.
At Financial Freedom, our fee-only financial advisors are also bound by fiduciary duty. They are required to take the fiduciary oath, which states that they must put their clients’ interests above all else, including their own. The avoidance of conflicts of interest at all times is what allows fee-only financial advisors to give advice based on each investor’s unique situation, and what makes them stand out in the crowded financial planning world.
What Commission-Based Financial Advice May Look Like
Now knowing what you know about fee-only financial advisors and fee-only wealth management firms, you may be (rightfully) wondering, why aren’t all financial advisors looking out for your best interest? The answer lies in the profits that commission-based financial advisors, along with the companies they work for, stand to make, as well as how they market their services to you, even offering to manage your portfolio “for free.”
Under the suitability standard, all financial advisors are required to recommend investments that are suitable for your portfolio. But the definition of suitability can be very generic. For example, given an option to choose two similar investments that are both suitable for your portfolio, a financial advisor who works on commission could choose the one that earns them a larger commission. In that situation, if it were you, which option would you choose if it could impact your income?
Commission-based (or fee-based) financial advisors are exactly what their name suggests. They are paid on commission, although the way they make their commissions can differ. Some advisors make money by selling certain products that their company touts. Other advisors make money for every transaction that they execute on their clients’ behalf.
In addition, if they work for a major Wall Street brokerage firm or investment bank, they will more than likely recommend their company’s own (and often, pricier) investment products, whether because they’ve been mandated to hit a certain quota by upper management or because, once again, they stand to earn a bigger payout. In either instance, even though the investments are being sold by reputable firms, you can lose a small percentage of your nest egg every time you buy or sell. In essence, you’re paying for the brand name of the investment bank, not necessarily for the quality of the investment product.
Why is This Important to You?
The distinction between commission-based financial advisors and fee-only wealth management firms and financial advisors may be a little blurry at first glance. To the untrained eye, they are both financial advisors who you hire to help you with investment management and retirement planning. The difference is subtle but important. Especially for your wallet.
In a 2015 study done by the Executive Office of the President of the United States, titled The Effects of Conflicted Investment Advice on Retirement Savings, an estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest. The report went on to say that the aggregate annual cost of conflicted advice is estimated to be about $17 billion each year. Breaking it down in more digestible numbers, if a retiree receiving conflicted advice takes withdrawals at the rate someone does who is absent conflicted advice, his or her savings would run out more than five years earlier.
Think about that for a second. When you retire, your savings could run out a whopping five years before it might otherwise, simply because of the financial advisor you hired to help you manage your retirement portfolio.
What’s worse, after a Wall Street lobbying group disputed the $17 billion number, a Bloomberg article said that they’re probably right. The number is probably much higher!
You want to be financially secure during your retirement years. If you’re looking for a financial advisor to help you manage your portfolio, be sure to choose a fee-only wealth management firm and financial advisor – an independent third-party advisor who does not work on commissions. Only by avoiding any conflicts of interest will you be sure that your financial advisor is not putting their interests above yours.
At the end of the day, we believe that it’s critically important to make sure that your advisor must work in your best interest (as a fiduciary) and that you fully understand all of the fees (direct or indirect) that you’ll pay for their professional services.