The Forked Tongue of Personal Finance

The financial advice world is awash in jargon and nuance.  This presents a problem for consumers because many common terms have no statutory definition and are frequently used with varying connotations in different contexts.  This definitional ambiguity may lead consumers to inaccurate assumptions about the nature of their relationship with the person or company they are enlisting for guidance.

By J.R. Robinson, Financial Planner (August 8, 2024)

The terms “wealth management” and “financial advisor” illustrate this point. A wealth management firm can be used to describe a company that focuses purely on portfolio management or it can be used to connote broader financial planning services beyond investments. Similarly, “financial advisor” is often used as a general term for all people who offer financial services (e.g., stockbrokers, financial planners, insurance agents, investment advisers, etc.). However, it is also frequently used as an informal title to connote objectivity in a product sales relationship in a way that terms such as insurance agent or stockbroker do not. 

The terms “fee-based” and “fee-only” are two more common common/loaded nuanced terms that are a common source of confusion among consumers.  It is critically important for consumers to understanding these nuances  at the outset of an advice relationship. While both terms refer to the manner in which a financial advisor (the general term) is compensated for guidance, neither has specific legal definition.  How these terms should be applied in the financial planning arena has been hotly debated for decades.  While my views on this subject obviously will not settle the debate, the goal of this essay is to make consumers akamai when they see these terms in use.

How Financial Advisors Get Paid

It is also critically important for consumers to have a full understanding of how they are paying for the financial products and services they are buying. The primary ways in which financial advisors may be compensated are sales commissions, asset-based fees, pre-determined dollar-based fees, hourly billing, and subscription fees.  Financial advisors and their firms may be purists insofar as they offer apply just one of these payment structures.  Alternatively, there are many firms and advisors who offer a combination or even all /of these compensation models.  The ability to offer multiple compensation models often requires licensing/registration with various regulatory bodies such as the Securities and Exchange Commission (SEC), Financial Industry Regulatory Association (FINRA), and/or the National Association of Insurance Commissioners (NAIC).

The Fee-Based vs Fee-Only Controversy

Within the financial advice community, “fee-based” compensation is a broad term that is meant to include all compensation models except commissions.  “Fee-only” compensation is often used to refer the subset of compensation models that excludes both commission-based and asset-based compensation (i.e., just flat-fee, hourly, and subscriptions).

The controversy regarding these terms involves perceptions of conflicts of interest among the various compensation models.  Specifically, advisors who are compensated via sales commissions (which may either be opaque or disclosed) are widely perceived deemed to have the greatest (or at least the most obvious) conflicts of interest with consumers.  In recent years, asset-based compensation has come under fire as the second most conflicted model since advisors have a self-interest in gathering client assets and in counseling clients against alternative portfolio management strategies that might require them to withdraw assets under management.  In contrast, advisors who offer financial advice under flat-fee, hourly, and/or subscription models are often portrayed as being free from conflicts of interest. Whether these conflicts of interest differences are as black-and-white as they appear is irrelevant to this discussion.  What is extremely relevant is that these concepts have become popularized. Specifically, consumers are increasingly aware that they should seek out “fee-only” advisors.

Since neither of these terms is regulated, it is not uncommon for asset-based advisory firms to market themselves as “fee-only” for its marketing value.   A review of the advisory firms in Hawaii finds that a majority of the companies using the “fee-only” term are actually using an asset-based compensation model. This does not sit well with the fee-only purists. Hence the running feud.   

However, the controversy even extends to those asset-based advisory firms that refer to themselves as “fee-based”  because some fee-only purists claim that the term “fee-based” is similar enough to “fee-only” that it is likely foster confusion among some consumers. 

In sum, now that you are aware of how these two terms are used, the easiest way cut through the nuances is to simply ask the prospective advisor how they are compensated.

Conclusion – The Author’s Two Cents

The purpose of this article has been to raise consumer awareness of the nuanced definitions and applications of “fee-based” and “fee-only” in the financial services industry.  Beyond that, I will add that I tend to fall in line with the purist crowd, insofar as I agree that flat-fee, hourly billing, and subscriptions are the only models that should be permitted to use include “fee-only” in their taglines.  I also am of the opinion that the term “fee-based” should be replaced by the more descriptive and less ambiguous “asset-based” moniker.

My opinion on this has been hardened over time by a long-running series of television advertisements from Fisher Investments in which representatives of the firm boast that Fisher is different from competitors because their asset-based compensation model means that they, “only do better when our clients do better.”  To me, the implication of this advertisement is that Fisher’s asset-based model is conflict-free.  Per above this is a misleading assertion. The conflicts of interest in the asset-based model are real and well-documented, and they are understood by the regulatory agencies.  I do not understand how the S.E.C. has allowed these ads to air.

At the same time, I am not entirely on board with the holier-than-thou sermonizing from the fee-only purists.  The popular perception that fee-only compensation models are free from conflicts of interest is flawed.  Although it has received scant financial media attention, the inconvenient truth  is that ALL advisor compensation models are conflicted.  

Hourly billing is conflicted because the advisor has an incentive to apply a heavy pencil when recording hours worked and to apply  “value billing” instead of actual hours worked.  Complaints about hourly billing practices are ubiquitous in the legal profession, but, for some reason, hourly billing is promoted as conflict free in the financial advice world. The conflicts are arguably more subtle in the flat-fee billing and subscription fee models, but in both the advisor has an incentive to do as little work as possible to earn the fee.

In practice, my flag-ship firm, Financial Planning Hawaii, operates under a tiered asset-based compensation model that effectively becomes a flat fee model of assets-under-management (AUM) of $5 million and above.  Several years ago, I established Fee-Only Planning Hawaii to cater to consumers who are seeking financial planning guidance that is decoupled from ongoing portfolio management. I am not suggesting that this is how everyone else in my industry should operate.  It is just how I do it, but the roots of my two-model approach lie in the “fee-only” vs. “fee-based” conversation.

A list of advisor compensation thought pieces I have penned over the years is provided below as “Related Reading.”

John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the Creator of the Nest Egg Guru Personal Finance website.

RELATED READING

The Future of Financial Planning Advice, Part 1 (Advisor perspectives, August 17, 2022)

The Future of Financial Planning Advice, Part 2 (Advisor Perspectives, August 23, 2022)

No Moral High Ground in Financial Planning Fee Debate, Nasdaq.com, 10-Aug-2015.

John H. Robinson 2007. “Who’s the Fairest of Them All? A Comparative Analysis of Financial Advisor Compensation Models.” Journal of Financial Planning. May2007, Vol. 20 Issue 5, p56-65. 8p.