In 2019, I wrote an article in response to the influx of robo-advisors in the financial planning space. Today’s investors can open an account, answer a few questions about their risk tolerance, and in minutes, a computer will create a balanced portfolio all without any human input—other than the investor’s, of course.
In that same article I also argued that today’s investors require much more than a uniquely appropriate ratio of stocks to bonds. If this was the sole purpose of financial planning, perhaps AI could have the run of this industry (I’ll be the first to admit that a computer can craft a more meticulously balanced portfolio of stocks and bonds than I can), but investors need more than a well-managed portfolio.
The fact is investors are more than the sum of their monetary inputs; they are humans. They are people living everyday lives with everyday problems and fears and dreams.
And those problems, fears, and dreams demand answers. They require the forethought, insight, and adaptation that only another human can provide through holistic financial planning. Planning that addresses not only one’s need for growth, but one’s ability to manage risk, overcome unforeseen disasters, and maximize the resources available to them in accordance with their unique desires and circumstances.
And so, robo-advisors are still operating in a human’s world. The planning space continues to be ruled by living, breathing financial advisors. The future—for independent firms, wirehouses, and family offices alike—is not in robo-advising, but in holistic financial planning.
Yet among advisors who offer such a service, there remains a division, two schools of thought that have become nearly as separate and oppositional as our political parties, though both proclaim to serve the same purpose:
Fee-based advising and financial product commissions.
WHAT IS THE DIFFERENCE IN FEE-BASED AND COMMISSION-BASED FINANCIAL SERVICES?
Fee-based financial planning involves a client paying a predetermined fee for financial advisory services, regardless of the financial products recommended or implemented. That fee may be a one-time payment for a comprehensive financial plan, a percentage of the assets under management (AUM), or both.
Financial professionals who operate on commissions are compensated by selling specific products such as insurance policies, stocks, bonds, or mutual funds.
A FLAWED ARGUMENT: FEE-BASED VS. COMMISSION-BASED FINANCIAL SERVICES
When assessing which compensation structure would be best for clients, at first glance, it would seem like fee based planning would be the obvious answer, since the client would be paying for the advice itself rather than just a financial product.
Consequently, there is a widespread belief in the investment arena that fee-based advisors have claimed the moral high ground, that only with this compensation model is a financial professional able to truly serve a client’s best interests above their own.
However, this scenario assumes that all clients are equal, that all investors are given the same chance to work with the same pool of advisors. It also assumes an advisor’s chief influence is monetary gain, rather than his or her fiduciary responsibility or commitment to clients.
As Ted Mathas, former Chief Executive Officer and Chair of New York Life, once remarked—where does the fee-based model leave the man who has but $1,000 to invest? How many financial advisors could stay in business providing a financial plan for $10 dollars? How many financial professionals could stay in business earning a $10 commission for a product sale?
Not many.
A lot of fee-based advisors simply do not serve clients with so little to invest. They cannot afford to—though these individuals are often the ones who need prudent investment advice the most.
So, we must ask ourselves: If fee-based advisors limit services to those of a particular net worth, is their model’s monetary influence any less detrimental—or more justified—than that of a financial professional who earns commissions from products sold?
We cannot assume that all financial professionals who earn commissions do not have the client’s interests in mind when making recommendations.
In fact, when a financial professional earns a commission on an investment product at a rate slightly higher than a fee charged by a financial advisor (say, 3% rather than 1%, or $30 rather than $10), it creates an ability to serve people who, in any other case, wouldn’t have the opportunity to work with an experienced, knowledgeable financial professional. It opens doors for the everyday investor to receive valuable, guidance and counsel.
THE QUESTION CLIENTS NEED TO ASK
So, if a client is searching for a financial advisor who will best serve him or her, the pivotal question at hand is not, “How is this person paid?” but “How do they serve their clients?”
Based on the examples above, both a fee-based advisor and a commission-based financial professional can work in service to a client’s interests and objectives. A commission-based financial professional can choose not to recommend a product if that product does not truly serve the client’s goals. A fee-based planner can offer candid advice to a client. So, the answer to who will provide best value to a client often depends on the client’s needs and financial situation.
When a financial professional or a financial advisor is held to a particular standard, he or she is still working on behalf the client. The degree of care and disclosure may vary based on the nature of the relationship. For example, in a best interest of the client standard if the product was not the best interest of the client, it would not be recommended, irrespective of fees or commissions. When serving in a fiduciary capacity, the advisor must disclose any conflicts of interest that arise. It means that no matter how the advisor is paid for his or her advice, that advice must align with the client’s needs, goals, and means.
So, in the search for a trustworthy advisor, one needs to shift focus. Rather than weighing the merits of fees or commissions, research the individual. Is he or she a CERTIFIED FINANCIAL PLANNER™ (CFP®) or investment advisor representative (IAR)? Both certifications hold the designees to a fiduciary standard, ensuring the client’s best interests are paramount in the planning and advising process.
THE RISK OF TRUST
Everyone needs the advice of someone they can trust—be it with $100,000 or $100 million. And this trustworthiness is not defined by fees or commissions, but by evidence of character. Trust is always a risk, and there may be professionals who will be inclined to tip the scales in their own favor rather their client’s interests. The focus of the investor, therefore, is to research thoroughly and choose wisely. Ask for recommendations from trusted friends and colleagues and commit to finding a financial partner who is held to a higher standard, regardless of how they are compensated.
