“Why Working with a "Fee-Only" Financial Advisor Makes Good Financial Sense” by Seth Swenson, MBA

​The term financial advisor is used by many different types of people and can mean different things. For the purposes of this article, the term financial advisor shall mean a person that provides financial advice and planning to individuals in order to help them save enough money to provide them income for their retirement years typically after they have stopped working. 


Fee-Only Financial Advisors also known as (AKA) Fiduciary Financial Advisors, are a type of financial advisor that provide objective advice for a fee. This fee is usually an annual percentage of the assets that they manage on an ongoing basis. For example, if the advisor’s fee was set at 1% of $500,000 of assets under management this would be an annual fee of $5,000. This fee may also be looked at on a quarterly basis as .25% or $1,250 per quarter.

Fee-Only Financial Advisors are typically Investment Advisor Representatives (IAR) of a Registered Investment Advisory (RIA). Fee-only Advisors AKA Fiduciary Financial Advisors provide objective financial advice. The fee-only financial advisor does not sell the client investments for “loads” aka commissions or 12b-1 fees also known as on-going 3rd party commissions. The fee-only advisor is also acting as a fiduciary and abides by the fiduciary standard.

The fiduciary standard essentially means that the advisor must always put the client’s best interest first. By charging a fee-only and not commissions, the fee-only advisor lowers the potential for conflicts of interest and is able to provide objective advice to the client. In fact, the client’s interest in having his or her assets grow are in alignment with the fee-only advisor’s interests. As the client prospers, so does the fee-only advisor. If the client’s investments decline in value, the fee-only advisor’s income will decline as well.

There is another type of financial advisor that is “fee-based”. This means that the advisor charges a fee and can also be paid commissions upon sales of investments such as mutual funds, by third parties. These advisors typically are employed by broker-dealers and are often encouraged to promote and sell certain investments. This can lead to conflicts of interest between the client and the advisor. This may cause the client’s retirement account to face annual fees that considerably higher than other similar investments. Ultimately, this may be problematic since this may lower the client’s portfolio return on investments.

One of the few predictable and consistent variables in the world of investing are the annual expense ratios associated with mutual fund investments and exchange traded funds (ETFs). These fees can range from .04% to 2% and are generally known to increase as opposed to decrease similar to inflation. By controlling these annual fees, an investment portfolio can at a minimum reduce the annual hurdle that must be overcome just to break even.

When it comes to individual investments such as individual mutual funds and ETFs not even the great Warren Buffet can predict the future. This year’s top performing stock is likely to wind up in the middle of the pack or down towards the bottom of the pack next year. This is due to the statistical phenomenon of regression to the mean.

Assuming that an investment portfolio #1 with fees that are 1% lower annually when compared to a similarly asset allocated portfolio #2, then portfolio #1 will save 30% in fees over a 30 year period. Over time this means that portfolio #1 would have been able to keep an extra 1% of his or her money invested in the financial markets. This would happen over a period of 30 years and add up to 30% more money invested over the period. This also means that portfolio #2 would have 30% less money to have invested over the same period.

By simply utilizing fee-only advisor an investor/retirement planner would likely be able to count on at the very least not paying as much in annual fees out of his or her investment portfolio. This means the hurdles to success are lower.

To prove the point that fees will erode portfolio returns, Warren Buffet the greatest investor in the modern era made a $1,000,000 bet in 2008 with the hedge fund industry that he could beat their returns over 10 years simply by purchasing a low fee S&P 500 Stock Market Index Fund. The fund he picked had  an annual expense ratio of just .04%.
Warren Buffett said that the hedge fund industry charged exorbitant fees that the funds' performances couldn't justify. A hedge fund called Protégé Partners LLC was willing to accept Warren Buffet’s bet. They ended up investing their money in a handful of other hedge funds and ultimately losing the bet.

Generally speaking, hedge funds are known to collect 2% of assets they manage annually regardless of the fund's performance (or underperformance) and take 20% of the gains in years when the fund has a positive return. At the end of 2017, Buffett's index fund bet had gained 7.1% per year, or $854,000 in total, compared to 2.2% per year for Protégé's picks – just $220,000 in total.

Conclusion:

When utilizing a fee-only financial planner investors will benefit greatly from lower annual fees and knowing that their best interest is being put first. Investors can feel confident knowing that conflicts of interest are lowered since the fee-only advisor cannot sell investments for third-party one-time commissions or annual on-going commissions. All of these aforementioned benefits can result in reaching retirement goals on-time and with enough money to retire with dignity and in style.

The investor must also not be confused by the term “fee-based” advisor which sounds so similar to “fee-only” advisor that it may lead a person to think that they are getting a fee-only advisor when in fact they are getting an advisor that is likely incentivized to sell them investments that pay them commissions leading to major conflicts of interest.

Finally, the investor should be aware of dually registered financial advisors that are both “fee-only” and “fee-based”. These advisors can put on either hat when convenient to them. This situation can be confusing and can lead to the conflicts of interest mentioned above.

In order to find a “fee-only” advisor one may simply search online for “fee-only” advisor and find them listed in the geographic area of choice. Be certain to verify that the financial advisor is indeed fee-only and also a fiduciary advisor.

Orchid Wealth Management is an independent Registered Investment Advisor headquartered in Palo Alto; Orchid a fiduciary advisory that is fee-only. Seth Swenson, MBA is President at Orchid Wealth Management, and provides objective financial advice.

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