How is your financial advisor paid? Who is a fiduciary?
As we have stated many times, it is crucial to understand how your financial advisor is paid. The three basic compensation methods are commission, commission and fee (fee-based), and fee-only. If your advisor isn't a fee-only advisor, they are either a commission only or a commission and fee advisor (fee-based advisor). Only fee-only financial advisors can be considered fiduciary advisors.
Commission Model - Not a Fiduciary
In the commission model, the advisor is paid based upon the volume of transactions. For example, a mutual fund with a front-end load will pay the advisor upon purchase of the fund. The obvious problem with the commission model is that it incentivizes high turnover (churning). Given this conflict of interest, it is difficult, if not impossible, to see how a commissioned advisor can claim to be working in your best interest. They are not fiduciaries for obvious reasons.
Commission and Fee Model or "Fee-Based" Advisors - Not a Fiduciary
Worse than the commission model is the commission and fee option, as this allows the advisor to both collect commissions and charge the client an annual management fee (e.g., 1%). These advisors frequently categorize themselves as “fee-based”, which creates significant confusion for investors who are seeking fee-only advisors. The investment statements we have seen from these advisors tend to have high cost mutual funds with built-in sales commissions and hidden 12b-1 fees (financial kickbacks to advisors from product providers and some mutual fund companies) along with some type of commission generating annuity policy with high surrender charges, and a limited number of index funds for good measure. They are not fiduciaries as they are not required to work in your best interest at all times. If they truly wanted to be a fiduciary to you, they would become Fee Only financial advisors and give up their sales commissions, hidden fees, and financial kickbacks.
Fee Only, Flat Fee Model = Clarity Capital Advisors - A Fiduciary
To clarify, fee-only advisors accept payment only from their clients and do not accept commissions or recommend investments with hidden 12b-1 fees. They are the only type of advisor that should be considered fiduciaries. Within the category of fee-only, there are three types of compensation—asset-based, hourly, and flat.
By far the most common, the asset-based fee is calculated as a percentage of the assets you place with the advisor to manage (e.g.1%). A commonly stated argument is that since the advisor is paid on assets, the advisor’s incentive is to maximize assets. Everybody wins! But do they? Certainly the advisor wins, but the client, not so much. Asset-based fees can be very expensive and become even worse as assets grow. To us, it makes no sense to pay an advisor based on something he has no control over—the performance of the financial markets. It can also lead to absurd situations such as a 30% raise in 2019 followed by an 18% raise in 2020 (based on the S&P 500 return). In fairness, it should be noted that asset-based fees decrease in a market downturn, but why should advisors receive a pay cut, especially during the time period when they are working their hardest to convince their clients to stay the course?
The hourly fee structure certainly has merit, as it’s consistent with how most financial professionals (e.g., accountants and actuaries) are paid when acting as consultants. One potential problem is the incentive to maximize the number of billable hours.
The flat fee structure is the one we utilize at Clarity Capital Advisors because we believe it is the one that is most fair to our clients. Advisors should be paid a fair, fixed fee (flat fee) based on the services they provide such as financial planning, retirement planning, asset management, their experience, and credentials.
Our flat fees include financial planning, retirement planning, and asset management services provided by a team of fee only, credentialed fiduciary wealth advisors for a fraction of the cost of other firms.
As your fiduciary, we make the following commitments to you
- We will always put your best interests first--ahead of our own and that of our firm and our employees. As defined by federal law, we will act as a fiduciary.
- We will act with prudence, that is, with the skill, care, diligence and good judgment of a professional.
- We will not mislead you; we will provide full and fair disclosure of all important facts and advisory fees we charge.
- We will avoid conflicts of interest, and we will not receive any fee or commission from any product or service we utilize on your behalf.
- We will fully disclose and fairly manage, in your favor, unavoidable conflicts.