Fee-Based vs. Fee-Only Financial Advisors

By Jeff White | AUG 30, 2023

There’s a lot to keep in mind when searching for a financial advisor. You’ll want to consider the types of services the advisor offers, the size of his or her client list and any account minimums the person may impose. But an advisor’s fee structure is one of the most important considerations. A fee-only advisor makes money solely from the fees he or she collects from clients, while a fee-based advisor can also receive third-party commissions for recommending certain products and services, creating a potential conflict of interest. It’s important to understand the difference between these two fee structures so you can work with an advisor who best suits your needs. A financial advisor can help manage your investments and create a financial plan for the future. Find an advisor today. 

What Is a Fee-Only Advisor?

A fee-only financial advisor is compensated exclusively by the fees that clients pay for advisory services like investment management and financial planning. As a result, fee-only advisors are not registered representatives of a broker-dealer or insurance company. The only service they sell is their advice. 

Why is this significant? When receiving advice from a fee-only financial advisor, a client won’t have to navigate the potential conflict of interest that exists then their advisor can earn third-party commissions for recommending certain products and services. Fee-only advisors are strictly in the business of serving their clients’ best interest since they do not have a financial incentive to steer their clients toward specific investment products or insurance policies. 

So how exactly does a fee-only advisor get paid? Fees for asset management are usually calculated as a percentage of assets under management (AUM). Similar to income taxes, most advisory firms use a tiered fee structure by which different fee rates apply to each part of a client’s AUM, although fee schedules vary from firm to firm.

For example, John Smith is a client of ABC Wealth Management. The fee-only firm charges an asset-based fee of 1% on the first $1 million a client has under management, 0.75% on the next $1 million and 0.50% on any assets that exceed $2 million. If John has $3 million under the firm’s management, he would pay $22,500 in annual fees:

$1 million x 0.01 = $10,000

$1 million x 0.0075 = $7,500

$1 million x 0.005 = $5,000

Total annual fee: $22,500

Beyond asset management fees, fee-only financial advisors may also charge fixed or flat rates for financial planning services, like tax management or retirement planning. Then again, an advisor or firm that offers comprehensive wealth management may bundle its investment advice and financial planning services into one fee. 

What Is a Fee-Based Advisor?

Fee-based financial advisors are also compensated by the fees that advisory clients pay. Like fee-only advisors, these fees are often based on a percentage of a client’s AUM. However, the opportunity to earn commissions from selling financial products or insurance is what sets fee-based advisors apart from their fee-only counterparts. 

Fee-based advisors may be compensated with brokerage commissions when executing trades as a broker-dealer. Fee-based advisors can also buy or sell securities from clients, which may result in a spread. 

While some fee-based advisors are representatives of a broker-dealer, others are insurance agents. In this capacity, a fee-based advisor can earn commissions when their advisory client purchases an insurance policy they recommend. For example, Susan Smith has a fee-based advisor who manages her investments for an asset-based fee. However, Susan decides she needs a new life insurance policy and approaches her advisor about her options. She ends up purchasing a policy from the insurance company that employs her advisor, resulting in a commission for the advisor. 

Some fee-based advisors can also earn extra money when selling mutual fund shares to advisory clients. In these scenarios, it is the mutual fund company that pays the advisor’s commission. So why does this matter? Third-party compensation can create conflicts of interest becasue an advisor who has an additional role as a broker or insurance agent has a financial incentive to sell you products that will generate a commission, even if that product isn’t necessarily the best option for you. 

When acting as a financial advisor, a fee-based advisor must abide by fiduciary duty and act in your best interests. However, when acting as your broker, the advisor must adhere to the less-stringent suitability standard. This FINRA rule states that brokers "have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer's investment profile." 

When receiving advice from a fee-based advisor, a client should know whether their advisor is delivering recommendations as their broker or as their fiduciary advisor and whether they stand to benefit financially from a particular recommendation. 

How to Determine an Advisor’s Fee Structure

The easiest way to figure out whether an advisor is fee-only or fee-based is simply by asking. While interviewing potential advisors, you should ask if they are a registered representative of a broker-dealer or insurance company, and if they receive commissions for recommending certain products and services. 

If you’re still only researching firms and haven’t yet begun interviewing potential candidates, it can be worthwhile to look up the firm’s Form ADV, documentation that must be filed yearly for registration with the U.S. Securities and Exchange Commission. Within these records, firms will disclose whether any of their employees are also representatives of a broker-dealer or insurance company, as well as any third-party compensation they may be eligible to receive.

Form ADV, which is broken into Part 1A and Part 2A, is available on the SEC’s Investment Adviser Public Disclosure website. While Part 1A is a fill-in-the-blank form, Part 2A is a brochure written in prose. The section titled “Other Financial Industry Activities and Affiliations” in Part 2A will disclose whether advisors are also brokers and/or insurance agents.

Bottom Line

Whether a financial advisor is fee-only or fee-based is an important distinction to recognize when searching for a financial professional. A fee-only advisor is compensated solely by the fees that clients pay for asset management or financial planning. A fee-based advisor, on the other hand, will likely earn similar fees for their advice, but also third-party commissions for selling investment products or insurance. This can lead to a conflict of interest, as a fee-based advisor has a financial incentive to recommend certain securities over others. Working with a fee-based advisor can still be fruitful, but it’s important to establish a clear understanding of how and when they may earn commissions. 

Tips for Finding a Financial Advisor

• When interviewing potential financial advisors, it’s vital that you ask certain questions, like whether they abide by fiduciary duty. To help you through this process, SmartAsset compiled a list of 10 questions to ask a financial advisor. 
• Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: iStock.com/Deepak-Sethi, iStock.com/shapecharge