What Is a Fee-Based Financial Advisor? - SmartAsset

When you work with a financial advisor, you’ll generally pay them via an advisory fee. This is often based on a percentage of your assets under management (AUM). Other common fee types are flat fees and hourly fees. Fee-only advisors make money solely from these advisory fees. Fee-based advisors, however, earn money in a variety of other ways in addition to the standard advisory fee. Make sure you know what fees you’ll pay and of any potential conflicts of interest your advisor may have. If you need help finding a financial advisor, consider using SmartAsset’s free financial advisor matching tool.

What Does It Mean if a Financial Advisor Is “Fee-Based?”

When you work with a fee-based financial advisor, you’ll likely agree to pay a fee in exchange for the services provided. This probably will be a percentage of your AUM. Some advisors charge a flat rate for all assets while others use a graduated scale in which the fee percentage decreases as your AUM increases. Some advisors may skip this altogether and instead opt for a flat or hourly rate. You may also pay a performance-based fee, a predetermined fee you’ll pay if your investments perform well.

In addition to earning money through one or more of these fee types, fee-based financial advisors also make money from other sources. In short, if your advisor earns money through anything besides a fee for the management of your portfolio, your advisor is fee-based rather than fee-only. Advisors won’t necessarily advertise their fee structures. Thus, it’s important to always ask any advisor you work with how they earn compensation.

How Fee-Based Financial Advisors Earn Compensation

Revenue streams for fee-based advisors vary on an individual basis. In addition to advisory fees, some of the most common additional income sources for fee-based advisors include:

As a broker-dealer: Some advisors are also broker-dealers or representatives of broker-dealers. In this role, they can earn brokerage fees for performing trading transactions. They may also sell securities that the firm owns, in which case the firm will earn money on the markup.
As an insurance agent: Advisors also may sell insurance policies or other insurance products. For this, they will likely earn a commission from the insurance company.
From mutual fund companies: Many people invest in mutual funds as part of their investment plan. Some advisors may receive a commission from the mutual fund company for investing your money in that fund.

These are the most common additional sources of income for these types of financial advisors. However, any money earned from a source other than fees for portfolio management make an advisor fee-based instead of fee-only.

Fee-Based Advisors and Conflicts of Interest

Fee-based advisors have a number of potential conflicts of interest. When advisors solely make money from managing a client’s assets, their only incentive is to maximize clients’ returns. Fee-based advisors, however, may have an incentive to make decisions that are not necessarily in clients’ best interests.

For instance, if an advisor receives a commission for every insurance product they sell, there’s an incentive to sell insurance to clients, even if they don’t need it. Furthermore, if an advisor makes a brokerage fee for every transaction they make, it would, in theory, behoove them to make more trades than they necessarily need to make. The same concept also applies to mutual fund commissions.

However, many advisors follow fiduciary duty and act in the best interest of their clients no matter what. Directly ask advisors whether they are bound by fiduciary duty. Even if your advisor is a fiduciary, make sure you know whether they have any potential conflicts of interest, especially if the advisor is fee-based. You always can opt not to buy the products your advisor earns a commission from if that makes you uncomfortable.

Fee-Only vs. Fee-Based Financial Advisors

The fee-only and fee-based distinction between financial advisors is one of the most important things to know when selecting one to work with. Understanding the differences between them will ideally allow you to pick an advisor you’re most comfortable working with.

As we state above, a fee-based financial advisor is one that not only earns income from working with their clients, but also receives commissions or other compensation from selling securities as a broker-dealer representative or insurance policies as an insurance agent. This standard leaves fee-based advisors with potential conflicts of interest due to their ability to earn money for selling specific things.

A fee-only financial advisor, on the other hand, entirely avoids these extra forms of compensation in their business model. In turn, the only compensation they earn is the advisory fees their clients pay them. Generally speaking, this is seen in the advisory industry as a more beneficial stance for a firm to take.

One important item to note is that SEC-registered financial advisors still abide by fiduciary duty, regardless of if they are fee-based or fee-only. That means that despite the potential conflicts of interest that come along with being fee-based, they are legally bound to work in clients’ best interests. The difference is that a fee-only advisor removes even the semblance of a commission-based conflict of interest by disallowing themselves to earn sales-related compensation.

Bottom Line

Fee-based financial advisors earn money from sources beyond the fees their clients pay, such as through commissions and brokerage fees. This presents a potential conflict of interest. It would be in the advisor’s interest to make transactions from which they would earn extra money even if it isn’t necessarily in the client’s best interest.

Fee-only advisors earn money solely through the fees their clients pay, and thus inherently have fewer conflicts of interest. If you’d like the peace of mind of knowing your advisor can never make money from selling you something, look for a fee-only advisor. Make sure you know how your advisor earns money and whether they have any potential conflicts of interest. If they do, find out how they attempt to mitigate them.

Financial Advisor Tips

There are many factors to consider when choosing a financial advisor. But finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Your financial advisor likely will invest your money in a number of different securities. To see how your investment portfolio may perform over a set number of years, use SmartAsset’s investment calculator.