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

When looking to hire a financial advisor, there are many things to assess such as the advisor’s qualifications, experience, and disciplinary history.  Additionally, it is critical to understand how the advisor is paid.  Knowing how an advisor is compensated can tell you a lot about their objectivity, transparency, and philosophy.

Fee-Based vs. Fee Only

Two terms that are frequently thrown around in articles and by advisors are “fee-only” and “fee-based.”  Fee-Only advisors are only compensated from the fees paid by their clients.  Fee-based advisors receive some of their income from fees clients pay and some from sales of investment or insurance products.  While this difference seems simple, it is key to understanding important differences between these advisor types and how they make money.

What Are Fee-Only Advisors?

Simply stated, fee-only advisors are paid only by their clients.  They receive no other compensation:  neither from investments the advisor recommends or insurance products the advisor suggests.  This compensation structure improves transparency and reduces conflicts of interest as clients know their advisor only receives compensation from them.  In addition, the fee-only model creates an architecture with greater objectivity.

What Are Fee-Based Advisors?

Fee-Based advisors receive income from client fees and income from the sales of mutual funds, stocks, and insurance products such as life insurance or annuities.  This compensation structure has imbedded conflicts of interest.  If an advisor is paid a commission for selling a particular mutual fund, a client may rightly wonder: is this the best investment to help the me reach my goals, is it simply what the advisor’s company has available, or was it chosen because it pays a better commission?  With fee-based advisors, the client may not be the only, or even top, priority.

History Provides Important Insights

Before the 1980’s, most advisors received the bulk of their compensation when they sold a financial product.  These advisors were often called stockbrokers.  Advisors that really wanted to help clients by providing comprehensive, objective advice realized there was so much more to helping clients achieve their goals than hawking products.  They also saw problems with the existing compensation structure as commissioned sales created a product-driven ecosystem that made the process opaque and set up conflicts of interest.

In the early 80’s a handful of advisors began offering advice without commissions that was focused on understanding clients and helping them achieve their goals.  As their numbers grew, a professional group was established to help these like-minded advisors share ideas, best practices, and create a new standard of excellence.  NAPFA, the National Association of Personal Fin ancial Advisors, was founded in 1983 for advisors committed to fee-only financial advice that is always in the client’s best interest.   Furthermore, NAPFA requires all members to have proficiency in financial planning as evidenced by their having the CERTIFIED FINANCIAL PLANNER^TM professional designation and by submitting a peer-reviewed financial plan.

Today’s Financial Advisor

While the number of advisors has grown substantially since 1983, fee-only advisors are still in the minority.  Although there are not exact numbers on how many advisors use the fee-only vs. fee-based compensation structures, NAPFA membership is one way to gauge the number of fee-only advisors.  As of 2020, there are approximately 3,800 NAPFA members nationwide – all of whom are also fee-only advisors. 

Where Confusion Takes Hold

Importantly, there are excellent fee-only and excellent fee-based advisors.  How advisors are compensated does not directly correspond to the quality of the advisor.  Interestingly though, it appears that some of advantages of the fee-only model have tempted some fee-based advisors to claim the fee-only title.  These advisors will refer to themselves as fee-only “80% of the time” or fee-only when they work with investments.  However, the fee-only designation should only be used by advisors that never accept commissions or compensation from any source other than their clients.       

In Conclusion

Today, there are so many advisor choices for consumers.  From insurance agents that can open IRAs to fee-only CERTIFIED FINANCIAL PLANNER^TM professionals that look to provide comprehensive advice on nearly every aspect of a person’s life, it can be challenging to choose the right advisor.  When assessing an advisor, it is imperative to know about the advisor’s training, experience, background, and philosophy.  Additionally, by understanding how an advisor is compensated, prospective clients will have a better idea what motivates the advisor, their degree of objectivity, and what issues may create conflicts of interest.