FYI: what "Fiduciary standard" means
Fiduciary duty is a legal requirement to act only in another party's interests. Currently, most of America’s largest investment companies are Broker-Dealers, which means they are not fiduciaries, but instead subject to a “suitability” requirement, which is a much lower target—it means the recommendations of their advisors must only be a good fit, rather than the best available option for your situation. (Some insurance products are even exempt from this requirement.) This creates potential conflicts of interest between advisor and client, due to the aggressive sales goals and commission-based compensation that are common in this country’s largest and most visible financial companies.
A Department of Labor’s Fiduciary Rule was set take effect in April 2017 (though the Trump administration rolled it back), advisors who managed retirement assets such as IRAs & 401(k)s would have been subject to the fiduciary standard and required to forego commissions in favor of flat fees. If they choose to continue receiving commission income, they would have had to present clients with a contract outlining their compensation and the potential conflicts of interest that will result from their recommendations. Professionals handling taxable brokerage accounts would remain unaffected and could continue receiving commissions. Though DoL received push-back from the industry, we viewed this is as a step towards greater consumer protection.
As a Registered Investment Advisor, all of our work is subject to the fiduciary standard. We continue to support a uniform fiduciary requirement for the financial industry.
FYI: HOW COMPENSATION WORKS IN THE FINANCIAL INDUSTRY
Compensation is only one aspect of an advisor’s practice. For more advice on what to think about when picking a financial firm, check out these helpful tips from John Oliver (or for a more in depth look see our thoughts on finding a Financial Planner).
Our View on Financial Industry Compensation Models
Fees can be paid for a variety of services, including financial planning, investment management, trust services, retirement plan administration, etc. We believe there are good, trustworthy people throughout the industry and in every compensation structure. We also believe it is easier to recommend the best solutions for clients when the advisor’s compensation is aligned with their client’s interests.
Commission products can deliver good solutions but we don’t like that the fees for these products are complicated and often left off statements. We’ve even met people who believed they received free financial advice because they didn’t see a fee on their statement.
Here are the types of fees that financial companies can charge. If you use financial products, you are likely paying at least one these fees:
FEE-ONLY ADVISOR FEES
Fee-only advisors can only be paid by you because they work only for you. This business model can best be described as fee-for-service. The payment can take the form of a flat dollar amount, an ongoing retainer, or a percentage of your Assets Under Management (i.e. account balances that are managed by the advisor). These firms don’t receive any commissions or compensation from industry partners, allied professionals or vendors. Though, do verify that that they don’t receive any kickbacks from investments they recommend or referral fees from CPAs or lawyers for new clients.
FEE-BASED ADVISOR FEES
These professionals can be paid in multiple ways by a single client. They may bill your Assets Under Management at an agreed percentage and/or charge flat financial planning fees and/or receive commissions for financial products that they sell. This is the most common compensation structure for most representatives of broker/dealers (most of the financial advertising you see) and independent advisors.
COMMISSION FEES
A large portion of the industry is still compensated primarily by commission. These advisors are paid every time you purchase a new mutual fund, insurance policy, or annuity. This is the case for representatives of insurance companies as well as some representatives of broker/dealers (i.e. stockbrokers).
TRANSACTION CHARGES
Firms that house your investment assets are called custodians. They will typically charge two types of fees. The first is a custodial fee (a very small percentage of invested assets) and the second is a transaction fee charged on sales and purchases of individual investment products. Transaction fees are minimal in passively managed portfolios but can add up if you are working with an active investment manager or day trading.
FUND MANAGEMENT FEES
Your portfolio likely contains mutual funds, exchange-traded funds, or index funds. These are products offered by Investment Fund companies. Their fees vary quite wildly for each fund and share class, and are usually higher for actively-managed versus passively-managed funds. Many investors aren’t aware of these fees because they are withdrawn before their asset value is calculated for their quarterly statement. There may also be a large fee or penalty on the purchase or sale of a fund if you haven’t owned it for a specific period of time.