The Difference Between Fee-Based and Fee-Only Advisors

Question: I'm currently searching for a good financial advisor, but I am a little uncertain of the payment terminology. What is the difference between a fee-based versus a fee-only advisor?

Answer: This question homes in on one of the most important considerations when hiring a financial advisor: How will that person get paid? Even if you've decided you don't want to work with an advisor who's compensated based on commissions (and therefore might have an incentive to favor one type of product over an another), it's important to understand whether a prospective advisor is fee-only or fee-based.

Fee-Only Financial Advisors
Fee-only advisors derive no compensation from selling commission-based products; any compensation they receive comes from clients. That compensation structure helps ensure that the advisor is working strictly on the client's behalf and isn't inclined to favor products that may not be in the client's best interest.

Your best bet for a fee-only advisor would be to find a registered investment advisor. RIAs manage more than $25 million and are registered with, and regulated by, the SEC. But fee-only financial advisors who manage less than $25 million can be just as qualified; the only difference is that they would be registered with and regulated by their respective states. RIAs have a fiduciary responsibility--the highest legal duty--to always put the client's best interests first, even if it may not be the most profitable to the advisor. Fee-only advisors may use different compensation structures. Here are some of the most common ones.

Flat Fees
An independent fee-only financial planner may charge a flat fee to complete a specific project such as a retirement-income plan. The client may pay a portion of the fee up front and the rest on delivery. Being able to pay a portion of the fees at the end gives the client more leverage in the client-advisor relationship.

Hourly Fees
Financial planners who charge by the hour may be your best bet if you need help getting your investment plan up and running but don't need much in the way of ongoing help. Expect to pay $150-$300 per hour for a pro with certified financial planner or chartered financial analyst credentials. The Garrett Planning Network is a national network of advisors who charge on an hourly basis.

Monthly/Quarterly Retainer
Other advisors charge a monthly or quarterly fee to work in an ongoing financial-services relationship. These fees vary widely depending on the complexity of the relationship and the amount of assets involved.

Asset-Based Fees
Independent fee-only financial planners may charge their clients a percentage of their assets for providing ongoing guidance and oversight of the clients' investments and financial plans. That kind of compensation structure will tend to make the most sense for those with complicated financial situations, such as family businesses or complex tax issues. A typical fee is 1% per year for up to $1 million in assets, though those with smaller accounts might pay 1.25%, says Tom Orecchio, chairman of the National Association of Personal Financial Advisers (NAPFA members don't take sales commissions; they are strictly fee-only.)

Fee-Based Financial Advisors
Fee-based advisors use a compensation structure that's a hybrid of what commission-based planners and fee-only advisors employ. They may accept compensation from clients as well as commissions from third parties, such as mutual funds or insurance companies when they sell their products. Therein lies the potential conflict of interest. While you may pay a fee-based planner less outright compensation than what you'd pay for a fee-only advisor, fee-based advisors can earn commissions by putting you in certain products, and the commissions they earn on some investments may be higher than others. Thus, the advisor may have a financial incentive to favor one product over another.

Some fee-based planners work under a suitability standard rather than a fiduciary duty. Whereas advisors who have a fiduciary duty should be able to demonstrate they've chosen the best products for their clients, advisors operating under the suitability standard should make recommendations that are suitable (though maybe not the best) for their clients based their time horizons and risk tolerance. 

In a similar vein, keep in mind that some fee-based advisors aren't financial planners, but investment advisors. Financial planners thoroughly asses your financial background before constructing complete financial plans that may include insurance, estate-planning, and tax issues. Investment advisors, by contrast, are primarily in the business of providing advice on investing in specific stocks, bonds, mutual funds, or exchange-traded funds. Additionally, they may only be able to recommend that you invest in a narrow range of products they have the credentials to sell rather than provide sound, high-level investment advice.